Lulu’s Fashion Lounge Holdings (NASDAQ:LVLU) has filed for an IPO during some of the most volatile times in the past few decades. Additionally, the fragmentation and volatility in the fashion industry is widely known. The huge cash burn in operations due to increased inventory costs is worrisome. Despite these concerns, the firm is growing its customer base. This is reflected in its increasing revenue trend.
LVLU was founded in 1996, headquartered in Chico, California. It is an affordable luxury online retailer for women’s fashion, primarily targeting Generation Z and Millennials. It offers fashion products such as dresses, bridal wear, accessories, swimwear and shoes. LVLU went public in November 2021.
The firm uses data to offer desired services to its customers. It does so by personally engaging with their customers on various social media platforms like Facebook, Instagram, YouTube, to name a few. It caters to customers’ personal preferences by leveraging their large dataset. Moreover, the marketing strategy includes these social media platforms to engage with its customers in a personalized manner. With the aim to maintain customer loyalty, LVLU uses “test, learn and reorder” strategy to offer new and personalized styles on a weekly basis.
Recent Corporate Performance
The Q3 2022 report shows the firm has sluggish net revenue compared to the previous year. Active customer base of around 3.9 million, 23% higher than the previous year. Net income and gross profit decreased since the IPO. The gross profit of 200 million and an operating profit of 10 million shows the firm is significantly investing its cash in SGA expenses. However, for a firm that has recently gone public, a significant amount of selling general & administrative costs are bound to increase. It includes online marketing and advertising costs to build a brand, and this is in line with any growth firm.
LVLU uses its own proprietary reorder algorithm to optimize inventory management. This data-driven strategy is particularly beneficial in the fashion industry as it helps in predicting the likelihood of the repurchasing of an item. This is crucial because a growth firm like LVLU, that caters to the personalized needs of its customers, cannot afford to have an outdated inventory. It is the finished product and not the raw materials that bring revenue. Thus, optimal inventory management provides room for new trends and needs, enabling customer retention.
The firm’s active customer base increased from 2.5 million in October 2021 to 3.2 million in October 2022 on a trailing twelve-month basis (TTM). It is likely that LVLU may have retained the majority of its customers while increasing its active customer base. Furthermore, the growing year-on-year revenue figures in the past couple of years, including the TTM revenue figure, support their efforts in building customer loyalty.
According to the October 2022 10-K report, the firm aims at growing its customer base and building a brand in foreign markets. However, management hints that there is a chance that this might not be cost-effective. In my opinion, while global customer base expansion is fruitful for the long-term, LVLU should, at present, focus on building a firm base in the US. Therefore, I highly doubt there will be a positive or significant profit margin, at least in the next couple of years.
At present, LVLU has a current assets to current liabilities ratio greater than 1, indicating that the firm has enough assets given any short-term liquidity crunch. On the long-term basis, the firm’s debt to equity ratio is around 0.6 which decreases the threat of solvency.
My primary concern regarding LVLU is that the affordable luxury industry is fragmented. It must compete with already established players like Polo Ralph Lauren (RL), Michael Kors (CPRI) and Coach (TPR). At the moment, I see no differentiating factor that would provide LVLU with a competitive advantage both in price and market share. Although the firm is heavily investing in its growth, it has to travel a long road to attain brand recognition in a highly competitive and volatile fashion industry.
Looking deeply into its financials, as with any growth firm, LVLU is also struggling to make profits. The increase in interest rates, inflation, and current market sentiment about the economy are providing strong headwinds, adding fuel to the fire. Although I have appreciated the firm’s optimal inventory management strategy, I am still concerned about its inventory costs. The inventory has almost doubled on a TTM basis, which led to a 60% decrease in its TTM cash flow from operations. This is affecting the firm’s cash on hand.
Due to its poor financial position, the firm is unable to operate efficiently at the moment. I can, for once, discount this for its heavy investments in its growth strategy. However, given the 71% drop in its price return (as shown in the figure above), it cannot afford to bleed further.
As the firm has not generated enough profits yet, it is wise not to value the stock price based on a Price to Earnings multiple. Instead, I have valued based on Price to Sales multiple.
The EV/EBITDA multiple of 11.5x of the firm is close to its sector median of 10.54x. However, the P/S (price to sales) value of the firm is 0.27 compared to the sector median of 0.92.
For the DCF valuation, the assumptions chosen are:
Cost of Equity: 15%
Cost of Debt: 16%
Tax Rate: 27%
24-month Forward Beta: 1.86
WACC (weighted average cost of capital): 14%
* The above values except beta are rounded to their nearest integers
The year-on-year free cash flow and revenue growth for 24 months were calculated by averaging their historical growth rates, respectively. Since the DCF method was applied to forecast short-term growth, a growth rate of 4% was used to evaluate the terminal value.
Note: I chose the average value to be a median instead of mean because of the outlier effect on the intrinsic value due to P/S multiple.
The price to sales valuation and other valuation approaches give contradictory results. At the current price of $3.30, the stock is trading close to my intrinsic median value. The stock is correctly priced. From a technical analysis viewpoint, a sudden plunge in the stock price in June 2022 and the stock’s inability to break the resistance is something to consider. It needs a strong catalyst to break the resistance, and I do not find any catalyst now. Additionally, I do not want to further invest in LVLU, given the external and internal factors affecting the firm that are discussed above. Thus, I rate LVLU stock a Hold.
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