Yesterday, Lululemon was on my accumulate list following what I viewed as a highly positive quarter and continued multiple contraction.
In the world of investing… I must keep an open mind, consider the other side of the argument, and respect risks. When new material information comes to light, regardless of any recent moves, the entire investment case needs to be revisited. When the data and information materially sour, I must genuinely contemplate implications. It does not matter if that happens 5 seconds after I make a buy decision or 5 years after doing so.
The Lulu story soured this morning in a rather meaty and important JP Morgan downgrade. I don’t care about their price targets or their ratings. But? I do very much so care about the data they’re citing in arriving at their decisions. Lululemon has been guiding to a sharp 2nd half reacceleration in its growth rates. Some of that is related to easier comps and better inventory matching, which are tailwinds that are still fully in play. A chunk of that confidence, however, was related to optimism surrounding new product launches – especially within women’s leggings and launches like “Breezethrough”
Well? JP Morgan’s note explicitly calls out serious leggings product issues in this launch. The product was hated by customers to a point of the firm actually pausing all sales of the new items. I don’t really know how the company could miss the mark by such a wide margin with their resources, market understanding and track record… but they did widely miss the mark.
That creates significant risk to profit estimates. A sizable piece of my bullishness centered on significant multiple contraction and seeing profit expectations as safe. Renewed downward pressure on estimates will reverse the multiple contraction and hurt the bull case. These innovation blunders cloud Lulu’s momentum and cast significant doubts on management’s ability to execute. When pairing this with the negative brand intent trends we’ve seen unfold for teens, leadership turnover and team restructuring, I think the story is changing here.
Citi also came out with a new note calling out credit card data pointing to financial disappointment this quarter and into the second half of the year. It also cited a weakening Chinese consumer hurting what has been its best source of growth as of late.
As a result of all of this, I cut about 54% of the position. I added a bit to Starbucks and Celsius to avoid cutting consumer discretionary exposure too much. I also boosted my Progyny stake by about 7%. The left is staying in cash for now.
Why didn’t I cut the entire position? This is still a strong (not pristine anymore) brand at a very compelling (albeit uncertain) valuation. It still has a massive international runway. It still sees its long term targets as in play. I would love to add more shares of this company back at much higher levels if they show signs of innovation resonating, store conversion improving with better inventory and this brand finding its footing.
I will continue to demand that my holdings thrive (or show signs of improvement for turnaround names). I will continue to dispassionately re-assess positions as my view of their performance changes. This has been a loser for me and I’ve been wrong here so far. I did trim at the top, but I should’ve trimmed more. There will be more losers and there will be many more winners. Just an inevitable piece of managing a portfolio and the ultimate reason to always stay diversified. I’ve included my updated holdings and my updated performance vs. benchmarks below (I am blue; Market/S&P is black; high beta benchmark is light brown). I will continue to update performance a few times a year.
