I decided to liquidate my stake in Lululemon. I have gone back and forth on this many times. I’ve gotten to a point where I am doing too much internal convincing and speculating to justify owning this.
Reasoning:
Last quarter was just good enough to keep me involved before the trade war chaos broke out. Newness was showing some signs of working and accelerating customer conversion. Performance outside of the USA was reasonably good. But still, those signs of progress all remained subtle and early.
I do not think the momentum in this business is strong enough to overcome the material and incremental trade war headwind. While the tariff drama could likely be short-lived in most places, it’s more likely to persist in China than anywhere else. It is absolutely true that news out of Vietnam to hopefully lower that tariff in the near future is highly positive for Lulu. But still, it sources 20% of raw materials from China and still it is obvious that the bulk of the trade war aggression will be directed there. As a Canadian brand, I don’t anticipate direct backlash against it in that nation. That’s not a risk like it is for Nike. But still, I do think the economic weakness stemming from all of this will be felt most in China. Consumers don’t buy as many $80 t-shirts when they’re worried about employment and paying bills. Lulu is heavily reliant on that market for its growth. Heavily.
To me, this is an unfortunately needed shift away from that market and away from consumer discretionary during a time when I think that’s prudent. I can’t stand selling near the lows, but I candidly do not think forward estimates are accurate and think they have much further to fall barring a sharp change in China. Yes, the multiple looks cheap… but I think that multiple is more vulnerable than anything else that I own. The actual financial hit from current tariff policy will be bigger than what Lulu modeled in its guidance.
Reasoning Part 2:
Furthermore, data out of the Piper Sandler teen survey released today points to more U.S. weakness with its young, affluent female customers. It’s now the third-ranked brand in the affluent female core and lost 4 points of market share Y/Y. It was number one for a long time. No more. Hollister and Brandy Melville both rank ahead of it after Lulu gave up the top spot last year. It hasn’t made any progress in recovering that momentum since. It also lost its top spot as the #1 fashion trend for affluent females.
We’ve been trained to expect Lulu’s traffic to outperform during bad parts of macro cycles as it takes more market share & displaces more competitors. That is no longer happening. This data hints at more share deterioration while traffic weakened alongside everyone else when macro became more fragile through Q1.
I’m a bit disappointed that things have come to this, but that feeling is irrelevant. Optimizing forward-looking risk/reward is what matters. Babies have been thrown out with the bathwater. Not all of those babies will be affected nearly as harshly as Lulu will if this persists. That makes risk/reward better for everything else that I own compared to this name.
So Why Not Starbucks Too?
A similar argument can be made for Starbucks in China as well. But I’m not selling that position. The China Starbucks business is already the black eye of that company and is mightily struggling. Nobody expects results there to look anything but awful while Starbucks is already seeking partnerships and potential sales of that business.
Conversely, China is the highlight of Lulu’s financials. It needs to put the team on its back and I don’t think it can.
And furthermore, I want exposure to whatever company Brian Niccol is running. He belongs on the Mt. Rushmore of non-tech public company CEOs and I am exceedingly confident in him navigating this challenge better than anyone else. They have great hedging programs in place, sizable bargaining power with vendors and a list of a few dozen countries where they can source coffee. Many of those are in Latin America, Africa and other parts of Asia where tariff levels are relatively lower (or soon will be). It’s easier for Starbucks to move supply chains than it is for Lulu to do so. I’m sticking with them.
Cash Position & Portfolio Update:
As a reminder, I still had cash worth about 4.1% of holdings left to deploy before this. The linked article works through all of that in more detail. It’s actually closer to 4% now that positions have moved a bit higher in recent days. This sale adds another 3.5% to the cash pile. I plan to use the 3.5% before the other 4% that was already available.
I was tempted to allocate some of the proceeds to other names today, but I want to respect the immense uncertainty and headline risk that is still loudly prevalent. Could we have found the bottom? Sure, it’s possible. But I’d like to have this dry powder ready to allocate if (not when, if) we see another material leg lower. It doesn’t feel prudent to add to positions into strength right now. I plan to continue covering Lulu and would be interested in owning this again in the future. I want to see more clarity out of China and better data out of the USA.
