Apparel, Footwear, and Softlines: Key Themes for 2013

Apparel, Footwear, and Softlines:

Key Themes for 2013 January 04, 2013

Christian Buss ([email protected], 212-325-9667)

Bilun Boyner ([email protected], 212-325-8717)

Darla Shay ([email protected], 212-325-2379)


Key Themes for 2013

Macroeconomic Backdrop

Domestic Spending Outlook Remains Healthy at 3-4% Growth

Some Reasons For Modest Optimism in Europe and Asia

Sector Themes

A Favorable Sourcing Environment For The First Time In Years

eCommerce Reaches an Inflection Point; Finally an Investable Theme

Heightened Competition in Hot Women’s Categories (Athletic Apparel and

Accessories)

2

Upgrades and Downgrades

Upgrading Under Armour to Outperform, TP to $59 from $57.

We see 5 positive catalysts in FY13, with primary benefits from channel expansion, a favorable sourcing environment, and improved supply chain operations. We believe

near-term downside risk from weather is largely baked in.

Upgrading Urban Outfitters to Outperform, TP to $48 from $42.

We expect outsized margin and revenue drivers driven primarily by merchandise improvements, price repositioning, and outsized ecommerce growth. Modest upside to consensus estimates should allow multiple expansion back to historical growth range.

Downgrading lululemon athletica to Neutral, TP to $80 from $86

Decelerating trends in mature markets and signs that product extensions have not met with strong consumer response suggest comp slowdown and further merchandise margin pressures are likely. We believe shares are range-bound near-

term.

3

Picking Winners

Stocks For 1H13

Limited Brands

Tumi

Under Armour

Urban Outfitters

Stocks For The Long Term

Nike

Ralph Lauren

VF Corp.

Wolverine World Wide

4

Near-Term Areas Of Concern

Abercrombie & Fitch

Coach

Columbia Sportswear

Deckers

lululemon athletica

Zumiez

5


Key themes for 2013




Sector Themes


eCommerce reaches an Inflection Point; Finally an Investable Theme


Accessories)

6

Personal income growth to remain healthy, in the 3-4%

range, even with a higher tax burden …

Personal income

growth to remain in

the 3-4% range,

supported by steady

wage growth, with a

partial offset from

higher tax burden.

(Our model

assumes $130B in

incremental tax

burden.)

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Y/Y

Ch

an

ge

in

Pe

rso

na

l In

co

me

(%)

Y/Y Change in Personal Income (SA)

y/y change in Personal Income (SA)

7

Source: Credit Suisse Estimates, BEA

Personal spending growth continues to emphasize

discretionary spending. Modest deceleration is likely,

however, with higher household operation spending

requirements

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

1Q

05

3Q

05

1Q

06

3Q

06

1Q

07

3Q

07

1Q

08

3Q

08

A1

Q0

9A

3Q

09

A1

Q1

0A

3Q

10

A1

Q1

1A

3Q

11

A1

Q1

2A

3Q

12

E1

Q1

3E

3Q

13

E

(y/y

ch

ange

no

min

al)

Y/Y Change in Personal Outlays

Non-Discretionary y/y Discretionary y/y

We expect

discretionary

spending growth of

3.9% in 2013

(a modest

deceleration from

5% growth in 2012).

8


Discretionary spending growth likely to reach alignment

with income growth with lower levels of catch-up

spending in 2012 (which followed several years of under-

buying)

Discretionary

spending growth

likely to be well

aligned with income

growth in 2013.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

1Q

10A

2Q

10A

3Q

10A

4Q

10A

1Q

11A

2Q

11A

3Q

11A

4Q

11A

1Q

12A

2Q

12A

3Q

12E

4Q

12E

1Q

13E

2Q

13E

3Q

13E

4Q

13E

Personal Income Growth Vs. Discretionary Spending Growth

Personal Income - Annualized Growth

Discretionary Spending - Annualized Growth

9


Savings rate likely to take a hit, though …

Expecting savings

rate to decline to

2.7% by 4Q13 from

3.6% in 4Q12.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

(y/y

change n

om

inal)

Savings Rate

Personal savings

10


Consumer credit usage is increasing but remains in a

range that has historically proven sustainable

Consumer short-

term credit usage is

increasing, but

remains in a range

that has historically

proven sustainable

($100-200B).

-$200.0

-$150.0

-$100.0

-$50.0

$0.0

$50.0

$100.0

$150.0

$200.0

4Q

20

08

1Q

20

09

2Q

20

09

3Q

20

09

4Q

20

09

1Q

20

10

2Q

20

10

3Q

20

10

4Q

20

10

1Q

20

11

2Q

20

11

3Q

20

11

4Q

20

11

1Q

20

12

2Q

20

12

3Q

20

12

Increase/Decrease in Consumer Credit ($B)

11


Most importantly, household balance sheets continue to

improve, with Asset/Liability ratios up to 5.8x … and likely

improving to 6.0x in 2013

Asset/liability ratios

are up to 5.8x from

trough level of 4.7x

in 1Q09 and are

likely to improve to

6.0x in 2013.

$0$10$20$30$40$50$60$70$80$90

4.0x

4.5x

5.0x

5.5x

6.0x

6.5x

7.0x

7.5x

8.0x

Ho

us

eh

old

As

se

ts (

$tn

)

As

se

t/L

iab

ilit

y R

ati

o

Household Assets & Asset/Liability Ratio

Household Assets Asset/Liability Ratio

12



Key themes for 2013




Sector Themes




Accessories)

13

Consumer spending in Europe is likely to remain tepid,

but return to positive territory is expected in early 2013,

with benefits from rising business confidence, declining

mortgage rates, and modest inventory restocking

We expect European

growth to rebound

in 2013, but remain

tepid at below 2%.

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

An

nu

aliz

ed

GD

P G

row

th

Euro Area

14

Source: Credit Suisse Estimates

Consumer spending in Asia is expected to remain above

6%, with China re-acceleration supporting the region

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

2013E 2014E

With China re-accelerating, we expect Non-Japan Asia to

grow at 6.6% in FY13, versus 6.2% in FY12.

15


Further Reading

European Economics - The consumer on the ropes

Global Economy: Monthly Review - Cyclical uptick, more likely

than not

Restaurants - Restaurants and the Fiscal Cliff

16

https://plus.credit-suisse.com/u/tPY0cT





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Key themes for 2013




Sector Themes




Accessories)

17

0.3

0.4

0.5

0.6

0.7

3/2009 9/2009 3/2010 9/2010 3/2011 9/2011 3/2012 9/2012

Polyethelene (NYM $/T)

Polyethelene (NYM $/T)

Polyethylene chip prices are up 5% Y/Y, but still 16% below May'11 peak levels

Core commodity costs have stabilized …

Core commodity

costs have

stabilized, with

cotton,

polyethylene, and

wool at normalized

levels.

$5.00

$10.00

$15.00

$20.00

1/2009 7/2009 1/2010 7/2010 1/2011 7/2011 1/2012 7/2012

19m Fine Wool (SFE AUD/KG) in USD

19m Fine Wool (SFE AUD/KG) in USD

Wool prices are down 19% Y/Y

$0.00

$0.50

$1.00

$1.50

$2.00

Jan-

09

Apr

-09

Jul-0

9

Oct

-09

Jan-

10

Apr

-10

Jul-1

0

Oct

-10

Jan-

11

Apr

-11

Jul-1

1

Oct

-11

Jan-

12

Apr

-12

Jul-1

2

Oct

-12

Cotton #2 (NYF $/IBS)

Cotton #2 (NYF $/IBS)

Cotton prices are down 19% Y/Y and 62% from the March'11 peak

18 Sources: FactSet

… and while labor rates are up …

Labor rates continue to rise double-digits across

developing markets.

39.5%

30.0%

14.1%

4.2%

Thailand Vietnam Brazil Mexico

2012 Wage Increases - Developing Markets

15.9%

8.6%

23.4%

Shenzhen Beijing Sichuan

2012 Wage Increases -China

19

Sources: Credit Suisse Estimates

… textile mills are in an oversupply situation …

Company - Type Date CS Analyst / Company Commentary

Texhong Textiles (2678.HK) - Textile Manufacturer

10/9/2012 Texhong indicated Jan-Sept and full year 2012 earnings are expected to increase substantially YoY, due to stable demand and the

cost advantage from the price difference between the international and Chinese cotton. The details indicated that the business

development in 3Q12 was ahead of our expectation. The company is likely to leverage more next year as 17% total capacity increase

(170,000 spindles) will all be in its new factory in Vietnam (trial production expected in 1Q13). The sales volume in Jan-Sept 2012

increased by 34% to 179,000 tons, or 78% of our old full year estimate. Although the overall market was only marginally better in

September, Texhong’s yarn sales volume showed significant sequential improvement, up 29% in 3Q12 versus the average of 1Q and

2Q12.

Shenzhou International (2313.HK) - Textile and Garment Manufacturer

9/4/2012 The company is likely to regain growth momentum again in 2013 with new fabric factory and new apparel capacity.

Weiqiao Textiles (2698.HK) - Textile and Garment Manufacturer

9/19/2012 During the first half of 2012, the Group's production volume of cotton yarn, grey fabric and denim were approximately 206,000 tonnes,

498 million meters and 42 million meters, representing decreases of approximately 37.6%, 14.1% and 16.0%, respectively, over the

corresponding period of last year. The decrease was mainly due to the Group's adjusting its production plans to lower the output with

a view to reduce inventory levels on the back of intense competition, caused by weak market demand for textile products and large

cotton price gap between domestic and overseas markets.

Outlook: Looking ahead, we expect the global economy to continue to pose challenges, and this will likely cause demand from

international markets to remain weak. On the domestic front, surging labor and other production costs, funding difficulties, and other

issues are not expected to be resolved in the near future. The trend for the cotton price gap between domestic and overseas markets

remains uncertain. As such, the operating environment for the textile industry in China will most likely remain challenging. With

growing domestic consumption, demand for various middle and high-end textile products and apparel is expected to grow. And

following recent reserve requirement ratio and interest rate cuts, it is expected that more favorable policies to stabilize the economy

will be issued in the second half of 2012, which would support the steady development of the textile industry in China. Although the

operating environment for China's textile industry in the second half of 2012 will remain challenging, we believe the industry will show

low, but positive growth.

Pacific Textiles (1382.HK) - Textile Manufacturer

9/12/2012 CS's recent channel checks indicated that the overall environment remains tough for export textile manufacturers in general. Pacific

Textiles is expected to record 6.0%YoY ASP decline and 5.8%YoY volume drop in 1H FY3/13E, while maintaining its gross margin

stable HoH.

Texwinca Holdings (0321.HK) - Textile Manufacturer

9/12/2012 CS's recent channel checks indicated that the overall environment remains tough for export textile manufacturers in general.

Texwinca is expected to post 15% YoY ASP decline and 5% YoY volume drop in 1H FY3/13E for its textile business. This time the

situation is even worse than the financial crisis in 2008. Following a record-low gross margin of 11.5% in 2H FY3/12 (vs the historical

range of 16%-23% for textile), we expect a further gross margin decline to 7.0% due to Texwinca’s inventory position and the

uncompetitiveness of domestic cotton price which hurt the exporters.

20

… as are major manufacturers

Company - Type Date CS Analyst / Company Commentary

Yue Yuen (0551.HK) - Footwear Manufacturer

12/4/2012"footwear manufacturing has entered into a new era of competitiveness." 3Q Revenue down 6.6% Y/Y, net product down 22% Y/Y. ODM volume down 13.2%

Y/Y.

10/11/2012 September operating revenue was down 4% Y/Y to $572M.

9/3/2012 Yue Yuen reported 9M FY9/12 results with revenue up 7.3% YoY, profit before tax up 10.0% YoY and net profit up 22.3% YoY. While the OEM/OEM margin

improvement slightly helped, the main net earnings difference was from taxation and minority interest.The OEM/OEM business achieved flat revenue in 3QFY9/12

alone, with ASP improvement in shoe manufacturing offset by sales volume decline. We believe this demand slowdown from major clients may last longer than

expected.

The retail business continues to see profitability pressure. We believe the inventory issue and fierce competition in the domestic sportswear retail market will

continue to affect it adversely. Therefore, we do not expect a quick turnaround in the near term.

Belle International (1880.HK) - Footwear Manufacturer/Retailer

8/21/2012 The Group’s revenue increased by 15.4% to RMB16,024.1 million for the six months ended 30 June 2012 from

RMB13,890.9 million for the six months ended 30 June 2011. This was mainly attributable to the continuously steady

growth of sales generated from both the footwear business and the sportswear business as compared with the

corresponding period of last year.

The gross profit margin of the footwear business was slightly lower than the same period of last year. The main reasons include 1) there was a high base last year.

In the first three quarters of 2011, market sentiment was strong, pushing unit price higher for footwear products, which in turn resulted in a higher-than-usual gross

profit margin for the Group.

2) in January and February of this year, there was excess inventory in the market and thus more discounting and promotional activities than the same period of

last year, which to a certain extent pressured gross profit margin for the first half of 2012. The promotional environment returned to normal levels since March 2012

as inventory clearance was largely completed, which helped gross profit margin normalize.

Footwear - Revenue increased by 17.2% as compared with the same period of last year. Same-store-sales growth, albeit lower than the high levels in the previous

two years, still stood at a healthy level in the mid-single-digit. Within the same-store-sales growth, the increase in average selling price was only low-single-digit, a

slowdown from last year’s relatively high levels. A

reasonable moderation of price increase reflects a moderating cost environment.

Stella International Holdings (1836.HK) - Footwear Manufacturer/Retailer

8/16/2012 Total revenue rose 1.6% Y/Y, as pressure on our manufacturing business was partially offset by the growth of our retail business. However, a combination of

slowing global demand and temporary capacity constraints caused by the

rationalisation of our production base and the control of overtime labour hours saw shipment volumes fall 11.9% to

22.9 million pairs, compared to 26.0 million pairs in the same period of last year.

The average selling price (“ASP”) of our footwear products rose 12.5% year-on-year to US$27.9 during the period,

which was mostly attributable to the inflation of input costs, higher recognition of our quality products, as well as ongoing

improvements in our product mix.

We experienced temporary constraints on our production capacity in the first half of this year following the closure

of a trade-processing factory in Dongguan (upon the expiration of the trade-processing contract with the local

government) and stricter controls on overtime hours. This was partially responsible for the fall in shipment volumes

over the period.

Outlook: We expect demand for our customised footwear products to remain steady, even as some clients delay orders due to

global economic uncertainty. The Group will continue to implement strict cost controls in order to maintain margins and profitability. ASP is expected to decrease

in the second half of the year, in line with declining input costs. However, this decline will be partially offset by continuous efforts to upgrade our product mix.

The Group expects to close the temporary capacity shortfall in the second half of the year as we ramp up production

at our new Guangxi, Hunan and Indonesian facilities

We also continued to implement our long-term plan of gradually shifting labour-intensive operations away from

coastal regions to our new low-cost facilities in inland China and South-East Asia. This will allow us to eliminate

long-term capacity constraints, secure a stable labour supply and control costs.

21

… the end result of which is favorable buys, with average

costs down 4-6% for spring and 2-4% for fall

9%

4%

-4%-5%

-4%

-8%-6%-4%-2%0%2%4%6%8%

10%

8-10% 3-5% -3-5% -4-6% -3-4%

2H11 1H12 2H12 1H13 2H13

Y/Y Change In Apparel

Costs (FOB)

6%

4%

-1%

-4%-3%

-6%

-4%

-2%

0%

2%

4%

6%

8%

5-7% 3-4% -2 to 0% -3-4% -2-3%

2H11 1H12 2H12 1H13 2H13

Y/Y Change In Footwear

Costs (FOB)

Favorable Apparel and Footwear buys likely to benefit

2013 margins.

22

Sources: Credit Suisse Estimates

Apparel advantaged over footwear given more

fragmented manufacturing base

-5%

-4%-4%

-3%

-6%

-5%

-4%

-3%

-2%

-1%

0%

1H13 2H13

Y/Y Change in Costs

(FOB)

Apparel Footwear

Apparel

manufacturers and

retailers are likely to

see the greatest

benefit, particularly

in 1H13.

23


Further Reading

Sourcing Environment Looks Increasingly Favorable Heading Into

2013

24

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Key themes for 2013




Sector Themes


eCommerce reaches an Inflection Point; Finally an Investable

Theme


Accessories)

25

eCommerce Reaches Inflection Point – Finally An

Investable Theme

eCommerce continues to gain share of the consumer’s wallet

− Retailers are investing more heavily into eCommerce channel to capture

incremental sales

With eCommerce growing as a percent of sales (long-term potential to

account for 20% of U.S. retail sales, from 6% in 2011), revenue growth

and leverage of fixed expenses for eCommerce advantaged will

outperform

Margin outperformance is also likely from companies driving sales into

higher-margin online channels (est. 500-750bp higher margin in online

business) Margin story developing with

eCommerce outgrowth

26

eCommerce to generate disproportionate incremental

retail revenue – retailers with eCommerce growth rate to

almost double brick-and-mortar

$2.25

$2.65

$3.05

$3.45

$3.85

$4.25

20

11

20

12

20

13

20

14

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15

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20

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20

29

20

30

20

31

(in

tri

llio

ns)

Retail Industry Revenue

US Retail Sales US Retail Sales (ex e-Commerce)

2.0% CAGR

1.2% CAGR ex. e-Comm

Source: Credit Suisse estimates, Comscore, US Census Bureau

We see long-term U.S.

retail sales CAGR

almost double that of

traditional brick-and-

mortar stores given

accelerated

eCommerce growth.

27

With higher profitability than stores, rising eCommerce

sales should lift retail’s overall operating margins by

~100bp


eCommerce

penetration increase

should lift retailers’

overall operating

margin (~500-750bp

higher OM for

eCommerce). 9.00%

9.50%

10.00%

10.50%

11.00%

11.50%

12.00%

20

11

20

12

20

13

20

14

20

15

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20

31

Retail Industry Operating Margin

Blended Operating Margin (Retail) Operating Margin (ex e-Commerce)

Retail's OM should rise as e-Com penetration increases

28

$250

$300

$350

$400

$450

$500

20

11

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20

29

20

30

20

31

(in

bill

ion

s)

Retail Industry Operating Profit

Retailer Operating Profit

Retailer Operating Profit ex e-Commerce Growth 2011-2031

2.5% CAGR

1.1% CAGR ex. eComm

Given faster sales growth and stronger margins, retailers

with greater exposure to eCommerce should see outsized

profit growth


With eCommerce’s

faster revenue growth

and stronger margins,

retailers with greater

eCommerce exposure

should see outsized

profit growth.

29

Look towards companies with high exposure to

eCommerce channel that can capitalize on current growth

1.7%

1.9%

3.5%

5.0%

6.0%

7.3%

7.7%

10.6%

13.3%

15.0%

20.4%

– 5.0% 10.0% 15.0% 20.0% 25.0%

COH

VFC

UA

RL

TUMI

ZUMZ

DECK

LULU

ANF

LTD

URBN

e-Commerce As Percent of

Sales

Source: Company data, Credit Suisse estimates. LTD reflects Victoria’s Secret Direct

Retailers with a historical catalog

business (notably URBN, LTD)

are currently ahead of the game.

Traditional specialty retailers

are investing to catch up.

Vendors are disadvantaged given

competition with multi-branded

sites and typically less direct

communication with customers.

30


Key themes for 2013




Sector Themes



Heightened Competition in Hot Women’s Categories (Athletic

Apparel and Accessories)

31

Heightened competition in categories where women are

(actually) still spending – activewear & accessories

We see increased competition in the two areas of strength within the women’s retail sector: athletic apparel and handbags/accessories

Activewear

1. Increase in dedicated specialty retail doors

2. Multi-branded retailers dedicate more floor space to women’s

activewear

3. Vendors place renewed emphasis on product

Handbags

1. Traditional apparel companies entering market more aggressively

2. Increased capital requirements

3. Limited price and product differentiation

Long-term threat to LULU

Long-term threat to COH

32

Retailers and vendors make greater push in women’s

activewear, as athletic and fashion continue to converge

With the convergence of athletic and fashion in women’s apparel, specialty, department, and sporting goods stores, AND vendors have place renewed emphasis on this category

Investing In Athletic Fashion: − GPS’s Athleta store expansion, GapFit, Active by Old Navy

− FL’s renovated Lady Foot Locker, new SIX:02 concept

− VFC to remodel 70% of Lucy stores and open 10 in ’13

− LTD’s VSX offering and increase in PINK’s yoga/activewear

− Department stores’ private labels

− UA’s hired new creative director for Women’s

− NKE to introduce new women’s retail concept in Spring ’13

− Fila launching three lines of ‘luxury’ fitness apparel

LONG list!

33

With additional focus on activewear, increased long-term

risk to lululemon’s competitive positioning and pricing

power

We believe lululemon brand and its product positioning has fended off competition due to: 1. Casual Luxury Positioning – Merchandise is an alternative to casual apparel

2. Broad Cross-Sports Appeal – Assortment balanced between specialized and

general athletic

3. Insider Status – Brand cachet, authenticity

However, we see long-term risks to its competitive positioning and pricing power as: − Women’s activewear gains shelf space across retail channels

− Vendors (UA, NKE et al) improve the fit and style of women’s offering

− Additional entrants are priced at a discount to LULU (LULU lowered prices on

select items for Winter ’12)

LULU has to offer the right balance of fashion and

athletic innovation to command premium prices.

34

Competition picking up across accessories market

Competition in the U.S. handbag market has intensified with entry of

traditional apparel brands into the category. Our analysis of the current

handbag market include:

1. Price is not a differentiating factor, comparable items sold within narrow pricing bands

across brands

2. Capital-intensive enhanced brand presentation (premium real estate, shop-in-shops) is

increasingly being used to help differentiate brands

3. Product innovation is increasingly challenging with fast followers quick to capitalize on

novel trends

Harder To Differentiate As Brand Offerings Increase

35

Will likely be costly for Coach to maintain market share of

handbag market, margins at risk if COH wants to maintain

share

With 28% market share, we believe new entrants target Coach, placing

the company in a more challenging competitive, particularly in the

department store channel.

Coach is responding by:

1. Developing high profile product launches

2. Investing in remodeled stores and shop-in-shops at

department stores

3. Ramping promotions to stimulate purchases,

particularly in the full price channel

If COH elevates discounts to maintain

market share, we see risk to its premium

margins

36

Picking Winners

Stocks For 1H13

Limited Brands

Tumi

Under Armour

Urban Outfitters

Stocks For The Long Term

Nike

Ralph Lauren

VF Corp.

Wolverine World Wide

37

See 5 Positive Catalysts in 2013

Benefits from channel expansion into department stores and athletic

footwear doors 1H sourcing environment should jump start margin

expansion (a long-term opportunity with UA OM’s 300-500bp below

peers.)

Benefits likely in 2H from recent investments in new supply chain and

sourcing staff

Likely validation of long-term growth targets from rollout of 2015 plan at

mid-year analyst day

Easy margin comparisons heading into 2H13 given mis-execution in

2H12

Upgrading Under Armour to Outperform, Raising TP to

$59

Under Armour has ample opportunity to

drive margin via improved supply chain

efficiencies.

38


$59

Risks from weak 4Q Weather and demand look priced In

Shares down 14% over past 3 months, (S&P 500, XRT up 1%)

Company guided conservatively heading into 4Q

− “With this updated outlook, I would like to provide some additional color

on several items. First on net revenues, the drivers of our net revenue

guidance remained relatively unchanged from our prior guidance and

assumed similar winter weather patterns as last year and more

moderate expectations within our e-commerce business.”

Company has already guided to 2013 revenues at low end of long-term

range suggesting limited guidance risk

See limited downside risks from weak

winter weather, but rather a cap on upside

potential

39


$59

Valuation premium justified with top-line growth remaining in 20-

25% range and margin expansion likely

Forward P/E of 30-35x has been sustained in periods of rising ROIC

− (Our model has lease-adjusted ROIC increasing to the high 20s over

the next 5 years, from 20%)

Under Armour trading at 31x forward P/E at the low end of its 5-year

range of 31-36x, and below the 5-year median of 32x

Expecting modest upside to consensus estimates, with an upside scenario

for $1.65+ in FY13 EPS (current consensus $1.49)

Valuation Weighting Price

Comparable Multiples 50.0% $58

Long-Term Growth Driver 50.0% $59

12-Month Price Target $59

40


Downgrading lululemon athletica to Neutral, Lowering

estimates and TP to $80

Signs of slowing momentum in more mature markets gives pause

Low single digit Canada comp in 3Q highlights challenges driving comps

in mature markets

− Canada stores are doing ~$3000/square foot, versus U.S. at $2000

If mature stores can’t comp at high-single digits or better, there is risk to

our prior sustained double-digit comp thesis

BASELINE UPSIDE DOWNSIDE

Comp Stores Sales - 2013

% Comp

Stores

Baseline

Comps

Contribution

to Comps

Upside

Comps

Contribution

to Comps

Downside

Comps

Contribution

to Comps

Year 2 Stores 17.5% 20.0% 3.5% 20.0% 3.5% 20.0% 3.5%

Year 3 Stores 17.5% 15.0% 2.6% 15.0% 2.6% 15.0% 2.6%

Year 4 Stores 6.2% 12.0% 0.7% 12.0% 0.7% 12.0% 0.7%

Year 5+ Stores 58.8% 5.0% 2.9% 10.0% 5.9% -2.5% -1.5%

Total Comps 9.8% 12.8% 5.4%

Slowing comp momentum in mature

markets adds risk to our prior “double-digit

comps are sustainable” thesis

41




Winter product lines designed to appeal to a mature customer base

appear to have stretched outside of the company’s comfort zone, with re-

pricing actions, broader discounting, and elevated markdown levels than

we have historically seen.

6%

9%

11%

8% 8% 7%

12% 11%10%10% 9% 9%

12%

8%

18%

0%2%4%6%8%

10%12%14%16%18%20%

6/1

1

6/1

8

6/2

5

7/9

7/1

6

7/2

3

7/3

0

8/6

9/4

10

/17

11

/5

11

/6

11

/27

12

/18

12

/28

Percentage of Apparel on Sale

32%31%31%

28%27%27%29%

30%

28%

33%33%33%31%31%

38%

20%

22%

24%

26%

28%

30%

32%

34%

36%

38%

40%

6/11 6/25 7/16 7/30 9/4 11/5 11/27 12/28

Average Markdown on Sale Merchandise

18% of product was on sale,

the highest level in recent

history

The average discount is also

at the highest level in recent

history, at 38%

42

Source: lululemon.com

Source: lululemon.com

With additional focus on activewear, increased long-term

risk to lululemon’s competitive positioning and pricing

power

We believe lululemon brand and its product positioning has fended off competition due to: 1. Casual Luxury Positioning – Merchandise is an alternative to casual apparel

2. Broad Cross-Sports Appeal – Assortment balanced between specialized and

general athletic

3. Insider Status – Brand cachet, authenticity

However, we see long-term risks to its competitive positioning and pricing power as: − Women’s activewear gains shelf space across retail channels

− Vendors (UA and NKE) improve the fit and style of women’s offering

− Additional entrants are priced at a discount to LULU (LULU lowered prices on

select items for Winter ’12)

LULU has to offer the right balance of fashion and

athletic innovation to command premium prices.

43



With slowing comp momentum likely, and further merchandise

margin pressure a distinct risk, multiple likely to be pressured

Forward P/E of 30-35x has come under pressure in periods of

decelerating momentum and lowered earnings power

See risk to consensus estimates with comps potentially coming in below

expectations. See downside scenario for $2.10-20 in FY13 earnings

power

Lowering FY13 estimates from 12.5%, $1.76B, $2.40 to 10%, $1.73B,

$2.29

Weighting Price


DCF 33.3% $84

Long-Term Growth Scenarios 33.3% $75


44


Upgrading Urban Outfitters to Outperform, Raising TP to

$48

We believe URBN has secular revenue drivers and margin expansion

opportunities that should drive modest upside to consensus 2013

Expect URBN to return to historical comp momentum with:

Improved merchandising as the new design team fully takes hold

− Holiday sales a validation point of return to authentic product and

differentiation. We expect URBN to outperform peers through holidays

(comps tracking HSD through early December) and in 2013

Anthropologie pricing adjustments including: 1) increased planned and

targeted promotions, 2) increased sub $100 product penetration and 3)

increased number of small ticket items (sub $50)

Outsized e-commerce growth with targeted investments in online

exclusives and differentiated online content

Easy comparisons, especially in 1H

45


$48

Distinct Drivers for Margin Expansion. Conservatively expect 150-

200bp Gross Margin Recapture Driven by:

Improved Full Price Selling with:

− Better inventory management: URBN inventory has been improving

through 2012; we expect URBN to enter 2013 with largely clean

inventory position

− Improved merchandising: Expect URBN to outperform highly

promotional teen retail environment with authentic product offerings

− Adjustments to opening price points (at Anthropologie): We believe

more appropriate opening price points will decrease the need for

clearance sales

Benefits from the more favorable sourcing environment

Outsized e-commerce growth (expect over 40% of incremental growth to

come from e-commerce over the next 3 years)

46


$48

eCommerce leadership, with 2013 benefits from accelerated

investments

Urban Outfitters has one of the highest E-Commerce penetrations of any

specialty retailer, with direct generating 20% of FY12E revenue.

− The company also has aggressive targets for E-Commerce penetration,

highlighting potential for E-Commerce to represent over 50% of sales

over the long term.

Big investments starting to generate returns, with growth accelerating to

36% in F3Q, from 16% in FY11, and 19% in 1H12:

− Doubling of web-based marketing;

− Re-launch of the Anthropologie customer loyalty program;

− Launch of an Urban Outfitters loyalty program;

− Hiring of Bob McElroy as Global Head of Direct-to-Consumer;

− Hiring of David Norton as Chief Analytics Officer; and

− Establishment of West Coast e-Commerce fulfillment and data centers.

47


$48

With early signs of return to robust growth momentum, double-digit

sales and high-teens earnings growth, we believe a significant

premium to mall based retailers and modest discount to more

immature concepts is justified.

URBN is trading at 21x forward P/E, slightly above the mid point of 5-

year range of 9-28x. We believe with signs of improvements in

merchandise and outsized e-commerce growth, a 23-25x multiple,

towards the high end of the historical range, is justified.

Weighting Price


DCF 33.3% $48

Long-Term Growth Driver 33.3% $48


48


Further Reading

The Rise of Athletic Apparel Across The Mall - NKE, UA, VFC Long-Term Beneficiaries As

Retailers Focus On High-Growth Activewear

COH: Downgrade to Neutral On Valuation And Signs Of Increasing Competitive Pressure

in North America

UA: Channel Expansion Opportunity, Supply Chain Initiatives Position Company For

Continued Earnings Momentum. Raise TP to $115

LULU: Product Availability Improves Modestly; New Assortments Extend Beyond Core

Athleticwear

URBN: Improved Full Price Selling and Pricing Adjustments Translates to Margin Capture

URBN: Pricing Study Highlights Improved Competitive Positioning At Anthropologie. TP

to $42.

49

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50

Companies Mentioned (Price as of 03 Jan 13)

Abercrombie & Fitch Co. (ANF, $47.11, NEUTRAL [V], TP $46.00) Coach, Inc. (COH, $54.95, NEUTRAL, TP $63.00) Columbia Sportswear Company (COLM, $53.45, NEUTRAL, TP $55.00) Deckers Outdoor Corp. (DECK, $39.24, NEUTRAL [V], TP $34.00) Five Below, Inc. (FIVE, $33.18, NEUTRAL [V], TP $37.00) Gap, Inc. (GPS, $32.09) Limited Brands, Inc. (LTD, $44.71, OUTPERFORM, TP $56.00) lululemon athletica, Inc. (LULU, $75.09, OUTPERFORM [V], TP $86.00) Nike, Inc. (NKE, $52.37, NEUTRAL, TP $51.00) PVH Corp. (PVH, $113.70, RESTRICTED) Quiksilver, Inc. (ZQK, $4.53, NEUTRAL [V], TP $4.00) Ralph Lauren Corp. (RL, $157.21, OUTPERFORM, TP $177.00) Tumi Holdings, Inc. (TUMI, $19.91, OUTPERFORM [V], TP $25.00) Under Armour (UA, $49.66, NEUTRAL, TP $57.00) Urban Outfitters, Inc. (URBN, $40.74, NEUTRAL, TP $42.00) VF Corp. (VFC, $151.79, OUTPERFORM, TP $182.00) Warnaco Group, Inc. (WRC, $71.90, RESTRICTED) Wolverine World Wide, Inc. (WWW, $40.91, OUTPERFORM, TP $52.00) Zumiez, Inc. (ZUMZ, $21.22, NEUTRAL [V], TP $23.00)

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I, Christian Buss, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

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Apparel, Footwear, and Softlines: Key Themes for 2013

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