Episode Transcript
The Finance Ghost: Welcome to episode 277 of Magic Markets. You'll have to excuse my voice, which probably doesn't sound great because I have a cold. However, the show must go on.
Moe, I guess if you go back through our library, there's a couple of shows every year where at least one of us is sick. Such is life, but we still make sure we do this every week.
This week, we are going to be looking at a couple of stocks which I'm quite excited to do. One is Ulta Beauty. The other is lululemon, which is the one that you looked at.
And unfortunately, I've been on the wrong side of lululemon. I waited to buy it at what I thought was a much better valuation. Premium brand - and as you are going to explain to us, it may not be a premium brand anymore!
So, a nice reminder of why you need to diversify, spread your risk and don't put everything into one stock, because lululemon has been pretty ugly, Moe.
Mohammed Nalla: Indeed Ghost, we're framing today's discussion as bad things happening to good brands. So, I think your bad voice is a bad thing happening to a good brand. lululemon, I mean, yeah, you've been on the wrong side of that. I was in the stock a long time ago. I took profit and thankfully stayed out.
I want to jump in because I think lululemon is still a good brand, but it's not being treated as this amazing, flawless growth compounder, which is what the market priced it as coming out of that COVID pandemic. This was the darling. Everyone said, this is the next Nike.
Or maybe they were right. Maybe it is the next Nike. And that's really come under significant pressure.
When we last covered this in Magic Markets Premium around a year ago, June 2025, the stock was trading around $261. And our big concern at the time was obviously tariff headwinds. We said that's really going to be an important point. We mentioned competition. And a lot of that has been validated because we were cautious around this. We said anyone going long would basically be speculating on a bounce. Be cautious around adding to your position.
I don't think you added to your position. So again, following and eating our own cooking effectively there, Ghost.
But the important point is that it's not just a tariff story. Tariffs were the original pressure point, but now they've kind of correlated and collided with other issues, like weaker demand in the core market, in the US market, the Americas in general. We've had some product launches that didn't go according to plan. Big margin compression, weak guidance. And those are all of the bad things happening to a good brand.
So, let's jump into it. I'm going to look at the numbers. I'll look at some of the tangential global stories. But looking first at the numbers, the Q1 numbers don't look like an absolute catastrophe at the top line, on the revenue line. But if you go further down that income statement, that's where the pressure comes about.
So firstly, at the top, revenue up 4% or 2% in constant currency. Yeah, very pedestrian, but not a disaster. It was still up. Comparable sales were up 1%. But then in constant currency (remember, there's the currency impact here, down 2%), not a great look. But that's not the pressure. The pressure comes through when you look at margins, and that ties into what's happening with the brand and the brand perception.
Gross margin down by a whopping 410 basis points. So that is a big, big smack.
If we look at operating margin, down 730 basis points. So that largely driving a massive decline in the earnings per share, down at around $1.69 versus $2.60 a year ago. That is massive pressure. And that's correlated with what you've seen in the share price.
Now that is really the issue. The brand is still selling product, but the profitability is being hit hard. And so, let's unpack why some of that's happening.
We start off obviously on the revenue line. Just in terms of overall appetite for the brand, if we look at that, the Americas - very important market there - in the Americas, revenue fell 3 to 4% depending on whether it's constant currency or dollars. Now that's a bad look, right? Comparable sales, 5 to 6% down.
But why I say it's not all bad news is, if you look at the global story we had highlighted in our bull box when we covered this a year ago: China. And how China was a massive TAM for a brand like lululemon. It really wasn't highly penetrated in that market.
And if we look at international revenue as a whole, up 22%, or 16% in constant currency. So lululemon's doing well globally, but they're not doing well at the core, in their engine, in the Americas market.
China specifically is up 23% in constant currency. So that was validated in the bull box. But unfortunately, if we look at the balance between the bull and the bear box, that's where the bear box starts to win out. Because the brand may be doing well globally, but not so well in the core market.
And then I mentioned guidance. I want to hear your views as an investor. What's your view on those headline numbers before I go into guidance? Because that's going to give us the outlook for not just the next quarter, but the year ahead as well.
The Finance Ghost: Yeah, look, I think it's the margins that would scare me there Moe, especially when you're looking at premium brands. You want to see margins going the right way or at least staying steady.
It’s when you see margins dropping in retail, then you are in serious trouble. I'll get to it just now in Ulta, but for example, their gross margins are going up.
That for me would be a big, big red flag. And I think that's coming through in the share price. You only have to look at how the market has reacted over the past year.
Mohammed Nalla: Yeah, and it's also tied to the guidance because on the guidance for the next quarter, management said revenue is around 2 to 3% lower. So that's the next quarter. That's uglier than we just had in the current quarter.
But then also the full year guidance was cut. So they were saying flat to down 1%. And that's not what you want to be seeing in a brand that had a lot of heat earlier on.
So, wrapping up, what changed from around a year ago when we covered this? The bull box was a strong balance sheet. Tick that - I think they still have a strong balance sheet. They're not distressed; they're sitting on a lot of cash.
We had broad product appeal, maybe a question mark around that. And I'll unpack what's happening in the market dynamic there. We had China. That's a tick. That worked out.
Brand strength and pricing power: I think a lot of pressure coming through with the pressure you've seen on margins. That's telling me that a stock, a company and a brand like lululemon is losing some of that brand cachet and pricing power.
It wasn't all good news. We were bearish on a couple of things. We mentioned tariffs, tick that box. Trading density, Ghost, is something you had actually highlighted quite prominently in that report. Trading density was under pressure, and I think that ties directly into what's happened in the Americas market.
We then mentioned that inventory risk was building. Guess what, inventories are still quite high. And again, playing to that, do you have the ability to move your product at these elevated prices?
Last point there was obviously competition. It has been a very competitive market. And there you've seen brands like Alo, Vuori, Skims. We've mentioned this in the previous report. They've all made up some market share in the core market, and that's why lululemon is not quite broken, but it's certainly a lot less special than the market once believed.
That's where I think the product and the brand heat has certainly leaked out a little. For a brand like this, product heat is very important. If you go onto the website now, I just had a look, they have a whole section that says: “We made too much, click here”.
That's the discounting that's starting to come through as the brand heat leaks out. Some concerns that we might actually see another Nike-esque type of story developing here.
Just to wrap up, I mentioned how the stock's now down around $115 versus $260 a year ago. It's almost around a seven-year low. And that's telling you that the market is now saying, “Is this still a good brand?”. The company, yes, still profitable, still a decent balance sheet, still a global growth story.
But the market has stopped giving it the benefit of the doubt, simply because the old bull case was: premium brand, pricing power. You can move goods without needing to discount that. I think a lot of those things have changed. Those are the bad things that have happened to what was a good brand.
I don't think the brand's dead, but the stock has now moved from this premium player to a turnaround debate. And that is a very different investment thesis and needs to be looked at with a different lens.
The Finance Ghost: Some of the headlines that I saw were that the CEO of lululemon was blaming a proxy fight with Chip Wilson for some of the bad sales, right? I nearly fell off my chair laughing when I read that.
I was trying to imagine some yoga enthusiast walking through a shopping centre and deciding not to buy lululemon pants because, oh my goodness, there's a proxy fight with the founder. Like, let me go shop somewhere else.
Do me a favour. Honestly, it's just ridiculous. So, when management starts with excuses like that, though, I get extra worried.
Mohammed Nalla: I didn't want to jump into the kind of shenanigans we've seen on management. There has been a management change. There is a new CEO at the company. The story with Chip Wilson's not a new one, goes back a very long time. Chip had a very bad parting with lululemon.
He had moved on a while ago. Then he became a lot more noisy recently. Obviously because of what's happened with the company, with the stock. He is still an investor.
When management's making those excuses, they're trying to gloss over some of the real issues in the business. I'm keen to hear what you've got to say about Ulta Beauty though, because from what I picked up in your intro, slightly different story than what we've seen at lululemon.
The Finance Ghost: Yeah, absolutely. I do just want to point out, new CEO of lululemon comes in in September though. So that is Heidi O'Neill. She was at Nike, so she knows a thing or two about a broken business. Kidding / not kidding. We'll have to see what happens there. So hopefully that will be some positive momentum.
Let's have a look at Ulta Beauty. So, this is another one we've covered a couple of times in Magic Markets Premium. A good example of a retailer that has seen its multiple derate as earnings expectations have moderated.
So, if you look at their P/E, 17.5x versus a three-year average of just over 18x. If you look at Price/ Sales, which is a somewhat simplified metric, currently 1.6x versus a three-year average of 1.9x. It's cheaper than it has been on average.
But the five-year average is the number that will really show you the derating versus the pandemic. Price/Sales has averaged 2.1x over five years, currently at 1.6x. Now that might not sound like a lot, only a 0.5x difference, but just think about it in percentage terms. That Price/Sales multiple is 25% lower than its five-year average. That's a material move.
The challenge is that the growth algorithm just isn't impressive enough to really excite the market. They promise top line growth of between 4% and 6%, excluding acquisitions. Yes, it's in hard currency, but that's still not exciting.
Then operating profit growth is expected to be between 6.5% and 9%. So operating leverage does do some work here. Add in some share buybacks, and they can squeak into double-digit EPS growth.
So that's what they basically promise in the market. And they're not shy to accelerate their buybacks in response to share price weakness. The share price is down 25% year-to-date and pretty much flat now over 12 months. That's a performance that lululemon can only dream of, but it's still terrible. So, buybacks are very helpful here.
Then if we just have a look at the latest numbers, Moe, they were pretty much in line with the long-term guidance. So comparable sales growth 5.4%. That's in range of that algorithm. 3.7% inflation, 1.6% volumes. That's fine. Nothing to get upset about there really.
And they did have a positive surprise in this quarter. Gross margin was up 100 basis points to 40.1%. So, this helped them drive operating profit up 11.6% and earnings per share up 15.5%. Way ahead of that long-term algorithm.
But here's the issue. It’s not sustainable, or at least unlikely to be sustainable. The company is guiding flat gross margin for the year, which implies that obviously in the remaining quarters they're going to come under pressure.
Now, analysts are worried that this is because of competitive forces more than anything else. And management, of course, as they do on these earnings calls, are very quick to respond by just pointing out all the things about the business that are good. Data, partnerships, other things that make it strong; and not really answering the question about competitive forces, which I think kind of does answer the question for you.
Just a few other interesting points I'll highlight here. They have 47 million loyalty members. That is still such an insane number. 47 million loyalty members. Just compare that to the size of a country like South Africa, for example. I mean it's incredible. 4% growth year-on-year.
So, it shows you just how big this business is, and it also shows you that they can grow that loyalty membership at a decent clip.
They did 40,000 in-store events in the last quarter alone. So, firmly an omnichannel play here. Yes, they see digital as a critical route to market, but they also believe that even digital native consumers are still craving that in-store experience. And they are investing in a new store in Times Square that is planned to open in 2027. So, keep an eye on that.
Lots of collabs with musicians, nothing unusual there. Lots of focus on festivals like Coachella and Lollapalooza. All very interesting.
And another point that I'll just raise quickly is that category-level initiatives can really pay off. In this case, fragrances has been a major focus of theirs with a high-teens comp (that's comparative growth rate). And this is something really interesting I think about retail, is that growth is really about figuring out which categories you can actually win in, and then these things roll up into a strong performance.
So, the summary of Ulta at the moment is that the business is actually doing really well, in my opinion. Their CEO is someone who's worked up from literally the shop floor, starting as an hourly worker at Target, all the way up now to be CEO of the group. They have strong support for that individual at the top of the chain there. And a good CFO.
There's a lot to like about the story and a lot of good stuff going on, but the guidance is where the market is unhappy.
I read a transcript from a conference that they presented at as well. A lot of questions, as you would expect, around are they being too conservative, are they holding back too much?
But then there's this macro story. There's the pressure on consumers, there's the competition, there's all the rest. So it’s nowhere near as bad as lululemon, I think. Of the two, if I was going to buy one now, I would go and buy Ulta. Because at least they've stuck to what they actually do. They are just a derating story. Whereas lululemon feels like they've just lost their way completely. Almost like what happened to Nike.
Mohammed Nalla: I did mention this on lululemon, but some of the reasons also that they cited for the bad performance was some product launches that they put out there that didn't go according to plan.
It's telling us a couple of things at lululemon. Maybe they're not sticking to the knitting. It's maybe not as premium as it used to be. Interestingly enough, at a gross margin level, lululemon still has higher gross margins than Ulta Beauty. I think it's like north of 50% versus a number in the high 40s at Ulta.
But the difference is also what you do then below that gross margin line, effectively. When you're looking at Ulta vs. lululemon, they might also be telling us something slightly different in terms of consumer appetites.
Because one is apparel, one is beauty. Beauty has been a really hot segment globally. I mean, if you look at Ulta Beauty, they go up against competitors like a Sephora. And we don't get Ulta Beauty up in Canada. We do get Sephora. I don't know if you get them down in South Africa, either of those?
The Finance Ghost: No; no, you don't.
Mohammed Nalla: In South Africa, the equivalent is MAC. I think that's owned by one of the other big beauty groups. Whenever I walk past a Sephora store in Canada, there are lineups. The store is just way too busy.
The fact of the matter is, yes, there's the in-store experience. There's something around that beauty segment I just don't understand. But it has been a very hot segment for a long time.
Previously that was reflected in the Ulta Beauty share price. Now you've actually seen some of that coming out as the stock has derated a little bit. Maybe that's an opportunity, Ghost. Maybe we should actually put Ulta back on the roster for Magic Markets Premium, for a deeper dive.
Well, let's just keep an eye on that over the next couple of quarters. It might warrant another look at whether there are some sectoral trends that we need to pay attention to here.
In an overall consumer story in the US that has been very nuanced, maybe beauty is actually defensive versus apparel, which has been a really toxic sector of the market.
The Finance Ghost: Yeah, maybe so. If you look at the local apparel players in South Africa, a bunch of them have done really well out of beauty as well. It is a very strong sector and that is certainly something to keep in mind.
I guess that's where we probably have to leave it for this week. But to our listeners, we hope you've enjoyed this quick overview of what's going on in the world of lululemon, which is basically just a lemon now (very sadly) and Ulta Beauty, which is a good business that has derated.
And if you did enjoy this stuff, then go and check out Magic Markets Premium, Moe, because I think that's where we do really our best research indeed.
Mohammed Nalla: Go and check that out. In Magic Markets Premium, we do a deep dive into a global stock every single week.
We unpack a bull box, a bear box. We do this fantastic look through in terms of some of the interesting numbers that come through there, and a technical chart that goes in.
So, there's a lot in the report, and it's only R99 a month. So go and check that out at magic-markets.com. We hope to see you as a subscriber.
We hope you've enjoyed this show. Hit us up on social media, let us know. It's at Magic Markets Pod, one word, at Finance Ghost and at Mohammed Nalla, all on X, or go and find us on LinkedIn. Pop us a note on there.
We hope you've enjoyed this. Until next week, same time, same place. Thanks, and cheers.
The Finance Ghost: Ciao.
