Thursday, June 7, 2012

LULU - the Bear Case for Earnings tonight

Price: $70


LULU has seen had huge media interest since it's debut, beating expectations in every quarter and seeing a crazy run-up in share prices.  It's overcome even the mysterious masterful short strategist in David Einhorn, as it continued to make highs into the first quarter of 2012.  Since most people are already aware of the bullish analysis, I'm going to add a few bearish points to allow the market to look a little deeper into the numbers.

The "O Leary Method"
If any of you have watched SharkTank, you'll know Kevin O'Leary as the most skeptical shark on the show, and one of the most common questions that he'll throw at someone who is building any business is in relation to the target market.  In the case of LULU, they have targeted Woman + Yoga which effectively caps their growth to a very specific niche.  This can be great during the growth phase, but if you see the current stock price in BBG which is focused on surfing gear - the limited appeal can most definitely start to create headwinds in future earnings potential.
The second part of the LULU story is - if the market is as profitable as it is so far, why hasn't a large sports player like NIKE or ADIDAS stepped into this yoga game; do they have patents that are stopping them?  The answer is there is nothing stopping them, and it seems like it's only a matter of time before they face competition from one of the larger sports apparel companies.

Inside Selling
Just refer to the below graphic it speaks for itself.


Something Fishy going on Overseas
The unsuccessful launch in Japan, and the repurchase of franchises in Australia have been gone so far un-noticed as there is minimal impact to a 1bn revenue - however these responses can indicate that the market maybe more U.S centric and LULU has limited overseas brand awareness and adoption.

Increasing Inventory
Looking at the past three years of annual earnings, we are seeing a trend towards increasing inventory costs, this is coming on the heels of online distribution channels, which should lower inventory holding quantities.  There are inefficiencies that are being added to their strategy of limiting items.  This is a combination that may take a few quarters to really hit the bottom line.

Cash Flow Conciliation Makes no Sense - Possibility of Increasing Accruals
We all know that the boon of all accounting scandals can be acutely sourced by examining the cash flow trends.  Interestingly, after inputting the same annual figures into my spreadsheet model, I am coming up with vastly different cash flow outcomes - whether I'm making mistakes in my model or there is some strange accounting going on, I will investigate further.

I am releasing these notes as the earnings are being released, because obviously I have large positions in LULU short. This trade is looking to be my biggest short trade since I started blogging.