ANALYSIS-Lululemon seen growing in lucrative niche market

Tue Nov 2, 2010 8:00am EDT

* Stock up 80 percent in 12 months, some say too expensive

* Success achieved through grassroots branding

* Cornering lucrative, but underserved female demographic

(In U.S. dollars)

By Solarina Ho

TORONTO, Nov 2 (Reuters) - Lululemon Athletica LLL.TO (LULU.O), one of a rare breed of Canadian retailers that has successfully expanded into the United States, may have more room to grow in the $15 billion women's fitness apparel market.

Affluent women willing to fork over $100 for yoga pants or $60 for a tank-top have helped the high-flying Canadian company wallop quarterly earnings expectations and drive same-store sales up 31 percent. That's nearly unparalleled in a soft retail environment where many chains are closing stores, not opening new ones.

Its shares have risen about 80 percent in 12 months on Nasdaq and roughly 40 percent since hitting two-month lows at the end of August.

Lululemon has dominated a lucrative niche market within an already intensely competitive athletic sporting goods industry.

Capstone Investments analyst Claire Gallacher, who has a price target of $50 and a "buy" rating on the stock, says Lululemon may have a premium valuation, but it also has much more growth ahead than its peers.

"I think that's one of the pieces of the story that excites a lot of investors," she said. "It is too expensive now? I don't think so."

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The stock currently trades around $45, slightly above the $44 mean price target among nine analysts, according to Thomson Reuters I/B/E/S.

While it does not differentiate its U.S. and Canadian same-store sales -- a key retail measure of stores open more than a year -- analysts estimate Lululemon's Canadian stores are raking in roughly $2,000 a square foot and its U.S. stores are generating sales about $1,000 a square foot -- strong figures for a company that is still growing.

Few Canadian retailers have found this kind of success expanding south of the border.

Even so, there are some rumblings about rivals lurking in the shadows, unsustainable sales growth and a premium valuation on the stock -- high, but not atypical for a growth company.

"I think the next six months are going to be a true test," said Jefferies & Co's Taposh Bari, among the more bearish analysts following Lululemon. Bari has an "underperform" rating and a target price of $32.

"I think for the amount of growth that is visible here ... valuation is just way too aggressive."

NEVER LACKED FOR COMPETITION

One thing is clear: Lululemon's success in yoga wear is unique.

"Under Armour (UA.N) has been trying for years. They size their yoga pants small, medium, large, and they put them in big sporting goods stores," noted Gallacher. "That's not where she's shopping and that's not how she's shopping. She buys her size 8 or whatever it is, in an environment that's comfortable."

Lululemon, which operates about 300 stores and showrooms in Canada, the United States, Australia and Hong Kong, has tapped into a demographic underserved by athletic brands -- women -- and competitors don't want to be left behind.

"It feels like it's their game to lose right now," said William Blair & Co analyst Sharon Zackfia.

Chief Executive Christine Day is no stranger to growth companies. She spent over 20 years at Starbucks (SBUX.O) and watched it grow from its first coffee shop outside of Seattle to a 13,000-store global chain by the time she joined Lululemon.

"She's very aware, having been with Starbucks through their hyper-growth phase, of how smart Starbucks was about having that infrastructure and really making sure they protected themselves as they grew," Zackfia said. "It's a very similar customer in some ways, with similar expectations."

Lululemon's success is attributed to a business model that marries fashion with functionality, quality and lifestyle, a grassroots branding strategy unlike its competitors and owning the distribution of its products. Its intimate boutique-style stores appeal to women who want the premium customer service.

Lululemon reaches out to local fitness instructors, driving brand awareness through word of mouth. Their stores and showrooms offer free classes, workshops and community events.

As interest in yoga levels off, it has expanded its offerings to include running wear. It is also dipping into children's clothing with its Ivivva Athletica line for girls.

"There have definitely been others that have come in and tried to take share, but Lulu not only has unique products, but really a unique selling environment," Gallacher said.

"I don't think that any other competitor really has the exact same offering that I think has helped Lulu maintain the hold that it has."

($1=$1.02 Canadian)

(Additional reporting by Euan Rocha; Editing by Frank McGurty)

((solarina.ho@thomsonreuters.com;+1 416 941 8067; Reuters Messaging: solarina.ho.thomsonreuters.com@reuters.net)) Keywords: LULULEMON/

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