Deep Dive: Lululemon ($LULU)

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Back in 1998, a surfer named Chip Wilson took a Vancouver yoga class and walked out annoyed by the clothes: baggy cotton that sagged and went see-through. So he sewed better pants from technical fabric and gave them to yoga instructors to wear while teaching. They became walking billboards. The pants sold out, and Lululemon was born. Over 25 years, that one idea, quality workout clothes styled for exercise or yoga, grew into a company worth more than $60 billion at its peak. Lululemon did not join the athleisure category. It invented it.

Now, the founder is at war with his own board, the longtime CEO is gone, US sales are shrinking for a second year in a row, and the stock is down ~80% from its 2024 highs. The fashion press says the brand has lost its cool, that kids are buying knockoffs from Costco, and that Alo and Vuori are the names on everyone’s feeds.

What they do: Lululemon sells premium athletic clothing, mostly through its own stores and website, with a lineup that runs from leggings and the famous Align pants to a growing men's range and a young footwear line. Because most of that product moves at full price through its own channels, gross margin is in the low to mid-50s, far above that of almost any other clothing company.

Why it crashed: The Americas, its largest and most profitable market, has not grown for about two years, with nine straight quarters of flat or declining same-store sales. In the latest quarter, America’s net revenue declined 3%, and America’s comparable sales fell 5% (-6% on a constant dollar basis) in the first quarter of fiscal 2026. Management has lowered its full-year outlook and now guides to a 0% to 1% decline in total net revenue for fiscal 2026. Other compounding factors were: margins squeezed by tariffs and discounting; a public proxy brawl with founder Chip Wilson that began after the company announced CEO Calvin McDonald's exit and only settled in late May; the leadership vacuum and the perception that Alo and Vuori are stealing the crown have caused Lululemon to fall out of favor with investors.

Possible catalysts: A product refresh already showing up in the spring numbers, a new CEO poached from Nike who starts in September, and a strange potential new tailwind: weight-loss drugs pushing more people into the gym and into new clothes.

The best way to segment Lululemon’s revenue is by geography. It reports three segments.

The most important metric is in the bottom row. The % of revenue from the Americas (the saturated market) fell from 85% of the business in FY2021 to 71% by FY2025, not because it shrank but because it grew more slowly, even as revenue rose from $5.3 billion to $7.8 billion. The two international engines simply grew faster. China Mainland revenue compounded at roughly 42% per year from a small base to $1.75 billion in FY2025, while the rest of the world tripled. So you are buying two businesses in one - a large, premium, very profitable Americas business not growing and in need of a refresh, and a smaller international one still growing like a startup.

Margins are under pressure. While gross margin was 56.6% last year, it dropped to 54.2% in the first quarter of fiscal 2026. Operating margin contracted sharply to 11.2% in Q1 FY2026, down from last year's 18.5% in Q1 FY2025, and well below its historical peak of 23.7%. The balance sheet remains resilient, showing $1.5 billion in cash and cash equivalents with essentially no debt. Meanwhile, management continues to aggressively buy back stock to defend the equity, purchasing 2.2 million shares for $358.3 million in the latest quarter, building on the $1.2 billion of stock repurchased last year.

A word on the margin. For all the talk of Lululemon losing its grip, the margin was remarkably steady till 2025, ending that full year at a robust 56.6%.

But now, gross margin has materially dropped. Gross margin plummeted 410 basis points to 54.2% in the first quarter of fiscal 2026. While a significant portion of the dip still stems from macro pressures, with tariffs causing a 280 basis-point reduction, markdowns have had a big effect as well. Markdowns are expected to rise 50 basis points in Q2 versus last year. Clear evidence is emerging that people aren’t chasing the product at full price like they used to.

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Americas’ revenue fell about 1% in FY2025. Americas’ revenue fell 3% in the first quarter of fiscal 2026, and same-store sales dropped 5%, with the full-year outlook dragged down to a 0% to 1% decline. The shopper’s complaint is blunt - the clothes got boring, and a $100 legging is a hard sell when it looks like last year’s. I’m sure the weak consumer sentiment isn’t helping.

In fiscal 2025, gross margin fell 260 basis points to 56.6% and operating margin fell 380 basis points to 19.9%, both down from their FY24 peaks, due to new US tariffs and heavier markdowns (discounts). The exit rate was worse, with fourth-quarter operating margin down 660 basis points year over year. In the first quarter of fiscal 2026, gross margin plummeted 410 basis points to 54.2% and operating margin collapsed 730 basis points to 11.2%, both down sharply from prior-year levels due to heavy US tariff headwinds, inventory provisions, and climbing store and proxy expenses.

Founder Chip Wilson, a major shareholder, ran a public campaign against the board for letting the brand go stale. In late May, they settled - Lululemon adds two of Wilson's nominees plus a third by October, Wilson stands down for 18 months, and Heidi O'Neill becomes CEO. Ex-CEO Calvin McDonald, who more than tripled revenue, left in January, and two interim co-CEOs are running things.

Vuori and Alo Yoga have pulled younger, style-led shoppers toward their own premium athleisure, and a reviving Nike is pushing back into the category it once owned. Each is taking share that used to come to Lululemon without a fight.

Lululemon’s response is more concrete than the stock price would suggest. The problem it admits to is stale product, so it is lifting new styles from about 23% of the mix toward 35% by spring, cutting its design cycle to 12 to 14 months from 18 to 24, and pulling back on discounting to sell at full price again. It also hired Heidi O’Neill, a 26-year Nike veteran, to run product from September. The plan is sensible, but US sales are still falling, and the turnaround strategy is unproven.

The board hired Heidi O'Neill, who spent over 25 years at Nike running product and brand, most recently through the stretch that sent Nike into its own long slump. Investors wanted a fresh product-first fixer for the stale-product problem, not someone from the regime behind a rival's troubles. The shares fell on the news, and she does not even start until September.

This question decides everything, so I went looking for evidence.

The bear case is real. Younger shoppers increasingly call Alo and Vuori the fresher brands. Alo has built serious heat on TikTok and holds something like 14% of the premium direct-to-consumer athleisure market. Vuori, valued at around $5.5 billion and preparing for an IPO, owns the relaxed men’s corner where Lululemon has always been weaker. Brand-tracker BERA scores Alo highly on excitement and sophistication. And the dupes - Lululemon got so annoyed it sued Costco last summer over look-alike apparel. Add a couple of see-through fabric episodes/scandals, and the ‘Lululemon is over’ story writes itself.

Now, the other side, which gets less airtime. Even as the US activewear market softened, Lululemon’s sales have not collapsed. Its stores still achieve more than $1,400 of sales per square foot, which almost nobody in apparel matches, and it holds $100-plus price points, the clearest sign a brand has pull. The same BERA report that flatters Alo and Vuori shows their overall scores still sit in the 40s, the getting-to-know-you zone, while Lululemon is the benchmark. And dupes are a problem only aspirational brands have.

My read: the brand has cooled, not collapsed, and the cooling lines up almost exactly with a stalled product engine. When the clothes stopped feeling new, the energy drifted to whoever was shipping fresh ideas. A relevance problem caused by a stale product is fixable with a better product. Also, a huge part of the slowdown is due to weak consumer demand (most consumer discretionary businesses are affected).

But I must say that I have a contrarian bent of thinking, and that maybe is coloring my analysis here. Maybe Lululemon is a melting ice cube in the US. I’ll be humble and acknowledge that I cannot predict women’s (who drive Lulu’s sales) clothing preferences over any time period. Lulu has strong moats (brand and distribution), but these can only go so far. My research on whether the brand is becoming irrelevant in the US is inconclusive.

The whole turnaround hangs on one lever: newness. Lululemon management has noted that new styles sell better than repeats and attract its highest-spending customers. So the number that matters most is the share of the lineup that is new. It fell to around 23% in mid-2025, roughly when US sales rolled over. The plan is to push it to 35% by spring 2026.

Lululemon has cut its main product development cycle from 18 to 24 months to 15 to 16 months and is targeting 12 to 14 months, while aiming to achieve about 20% more volume on its winning styles this year. It hired a Chief AI and Technology Officer to speed up design. So the strategy is not just a slogan.

So far the signals are mixed, not the clean win the bulls want. On the Q1 call, interim CEO Meghan Frank admitted that recent launches did not wow shoppers and that a wave of negative brand chatter dented traffic, though management still expects full-price selling to turn positive starting in Q2. The newer footwear push is one genuine bright spot - the Beyondfeel running shoe and Cityverse sneaker have seen solid sell-through since their 2024 debut - but it is still a small part of the mix. None of it has translated into any material improvement in the Americas numbers yet.

Coming to the biggest catalyst. The founder will now have 2 of his nominees on the board. And Heidi O’Neill, the 26-year Nike veteran who helped grow that business from $9 billion to $45 billion, takes over in September. Nike is primarily driven by sales to men, while Lululemon is driven by sales to women. Most brands tend to do well with either men or women. Even though Heidi helped grow Nike’s women’s division, I don’t think Nike has done very well with women’s apparel either. This is my pushback against this appointment, and I do agree with the market’s view that Nike itself is not a poster child for brand success in the last 5-10 years. So this appointment does not inspire much confidence.

Here is what makes this interesting. Weight-loss drugs (GLP-1), including Ozempic, Wegovy, and Zepbound, are changing how people shop, and their mechanism of action works in three ways. People lose weight, usually 10 to 20% in year one, which is one to five sizes, so they rebuild a wardrobe. They start exercising, and in one survey, the share of people exercising weekly roughly doubled, from about 35% to 71%, creating a new pool of buyers for workout gear. And people who pull off a visible health change like to show it, and premium athletic wear is how.

The scale is large. About 1 in 8 American adults has tried a GLP-1 and roughly 6% are on one today, and Bernstein estimates the wardrobe churn could add $3 billion to $13 billion a year in US apparel spending. Almost all of it is American, which lands it squarely on the 71% of Lululemon’s business the market has written off. But the catch is real - Bernstein’s bigger winners are the off-price and value names, not premium, since shoppers buy cheap clothes while their size is still moving, and only the higher-income end of the GLP-1 crowd is the kind who will pay $100 for a legging.

Many brands have faced the same stale-product issues that Lululemon faces now, and the pattern in the table is not random. The ones that came back, Abercrombie, Crocs, and Lululemon in 2013, rebuilt the product and still had a wanted brand underneath. The ones that stalled either spent their brand equity on discounts (Under Armour, Gap) or missed a cultural shift they could not discount around (Victoria’s Secret).

Lululemon looks like a winner on what matters most - its gross margin is still in the 50s, so brand equity is intact, and it is moving early while remaining profitable. What I am wary of is the new CEO, hired from a weak (brand perception wise) Nike. Whether the new management will be able to pull off a turnaround cannot be answered by looking at historical precedents. And so even this is inconclusive. I have no confidence in predicting a turnaround at this stage. I will rather wait for it to happen.

We value Lululemon using a simple DCF model. One key caveat is that the model is my effort to put numbers around the story - Lulu’s model is very sensitive to the exit multiples, which will depend on the same-store sales growth for the Americas. This makes the DCF highly unreliable: as a small negative same-store sales growth versus a +2% figure will drive a material difference in the intrinsic value.

By the end of this decade (even right now), Lululemon is a maturing premium brand growing in the high single digits, so we set the multiple based on where mature branded apparel and footwear trade. The apparel group sits around 14 times forward earnings. Nike, the closest comp, trades ~25x-30x, but on depressed earnings, so normalized, it is lower. Ralph Lauren and Tapestry sit around 20 times, and Deckers, behind UGG and Hoka, at just 15 times. A premium, net-cash brand still growing 7% belongs in the upper half of that range, not above it.

So I conservatively use 15x FCF in the base case and 10x FCF in the bear case, where the brand keeps fading and the stock trades like tired apparel names.

The base lands near $153 versus ~$116 today, and the bear near $88. Unfortunately for Lululemon, unless they print a turnaround in the Americas, the market will not be interested in this name.

Brand fade: If the US lineup fails to re-engage and comps stay negative, premium pricing will erode. This will be a slow death for the brand, and the stock will be a value trap. If it loses relevance in the US, the brand may lose its pull in China and the rest of the world as well.

Margins: Tariffs and markdowns could prove stickier than we assume, holding cash flow margin below our recovery path.

Leadership: Poor decisions by the new CEO will be difficult to recover from.

China’s growth falters: This would remove one of the bright spots from the Lululemon story.

We rate Lululemon a ‘HOLD’ with a ‘Sell on Rallies’ bias. This is in the too-hard bucket. Essentially, we will wait and watch the KPIs and revisit the thesis post-recovery (if any) in the US same-store sales.

The base case materializes only if the US stops shrinking (if and when that is) and starts growing again, with margins climbing back up. Take that away, and you fall straight back to the bear case. So the value is real, but it hangs on one thing, and that one thing has not shown up yet. That is why we are staying away. We will be patient here.

Rebound Capital’s work is provided for informational purposes only, is intended solely for readers in the United States, and should not be construed as legal, business, investment, or tax advice. You should always do your own research.