Lululemon Athletica Inc.

Summary

Lululemon designs athletic apparel, has it made by contract factories in Asia, and sells it mostly through its own 825 stores and its own websites. It keeps both the manufacturer's and the retailer's margin. That is why it historically earned 22–24% operating margins, roughly double a typical apparel company.

Q2 brought the second cut to full-year guidance in three months; the revenue forecast is now $1B below what management set in March. Revenue fell 4% and comparable sales fell 10% in constant currency. The stock fell 17% the next day to an eight-year low and closed today at $96.88, down about 81% from its December 2023 peak.

Three things in the Q2 filings matter more than the headline and were not the focus of the call:

• The reported margin improvement is a one-time refund. Gross margin "rose" 200 bps to 60.5% only because $134.5M of tariffs paid in 2025 were refunded after the Supreme Court struck them down. Without it, gross margin fell 360 bps and operating margin fell from 20.7% to 13.2%.
• The damage is volume against a cost base built for growth. Excluding the refund, product margin fell 150 bps. Fixed costs in stores, distribution centers and head office rose 630 bps as a share of revenue. Square footage grew 11% while store revenue fell 6.5%.
• China stopped growing. It was the growth engine: +29% in FY2025. In Q2 it fell 2% in constant currency, with comparable sales down 8%. Management attributes this to brand sentiment, not the economy.

On the other side, the company is generating cash and has no debt. First-half operating cash flow was $589M against $210M a year earlier. Inventory is clean: units are down 7%. The buyback continues, and the new CEO, Heidi O'Neill (ex-Nike), started on September 8.

Two days before the print, the founder's holding company entered a two-year prepaid forward with Goldman Sachs on 13% of his stake. The filing says this is not a change in his view of the company.

Valuation. At $96.88 the market is pricing roughly no margin recovery: margins stay near this year's ~13% and returns fade. My base case assumes the decline stops in FY2027 and the operating margin recovers to 17% by FY2031. On that base, at a 10% cost of capital derived from market data, and on the more defensible of two terminal assumptions, the shares are worth about $112. If the decline does not stop, they are worth about $76. The disagreement is about the next two years of margins, not about the distant future.

Part 1 — What the company actually is

A vertical apparel brand

Lululemon does three things itself: design, brand, and retail. It does not own factories.

The consequence: Lululemon captures the retail margin, but it also carries the inventory, the leases, and the fixed cost of the stores. When demand falls, there is no wholesale customer to absorb it.

The 10-Q is explicit about what protects the brand and what does not: "Our fabrics and manufacturing technology generally are not patented and can be imitated by our competitors." The intellectual property in the fabrics mostly belongs to the mills. The moat is the brand and the store experience, not a patent. The Q2 10-Q added new language about "dupe" products spreading through social media.

Three segments, very different economics

First half of FY2026:

Segment margins exclude corporate costs: design, sourcing, supply chain, technology, brand marketing, head office. Those costs total 15.8% of revenue, so segment margins overstate what each region earns.

China earns the highest margin of any segment. That is why its slowdown matters more than its 18% share suggests.

Two ways revenue grows

This distinction runs through the rest of the report.

• Comparable sales: stores open at least 12 months plus all e-commerce. This is the measure of demand from existing capacity.
• Non-comparable revenue: new and expanded stores, outlets, pop-ups, wholesale, and third-party licensed stores (53 locations, up from 45).

Adding stores can make total revenue look better than demand. In Q2, non-comparable sources added about $83M across the three regions ($29.5M Americas, $23.0M China, $30.2M Rest of World). That is why Americas revenue fell 8% while Americas comparable sales fell 12%.

Part 2 — The one mechanism that matters

Fixed costs meeting falling comparable sales

Lululemon's cost structure has three layers:

1. Product costs: fabric, factories, freight, duties, markdowns. These move with each unit sold.
2. Other cost of sales: store occupancy and depreciation, distribution centers, product teams. These are fixed. They are inside cost of goods sold, so gross margin is not product margin at this company.
3. SG&A: head office, marketing, technology, store labor. Mostly fixed in the short run.

When comparable sales rise, layers 2 and 3 spread over more revenue and margins expand. That is what built the 23.7% operating margin in FY2024. When comparable sales fall, the same arithmetic runs backward, and the company is still adding stores, square footage and a new distribution network.

Where the pressure landed in Q2

Excluding the refund, product margin fell 150 bps and foreign exchange added 20 bps. Fixed costs took 630 bps, about four times the product-margin hit. The problem is not pricing power. It is volume.

Three consequences follow.

C1. Revenue understates the demand decline. New capacity fills part of the gap. Store revenue fell 6.5% year over year while square footage grew 11%, so store sales per square foot fell about 16%. That is the number most directly tied to whether new stores earn their cost of capital. Management still says new stores pay back within about a year.

C2. Depreciation is rising on its own. First-half depreciation and amortization was $277.7M, up 18.5%, on flat revenue. Capex this year is guided at $680–700M, about 6.6% of revenue, funding stores, a distribution center program and technology. Those costs arrive whether or not comparable sales recover.

C3. Right now the headline cannot be read without adjustments. Q2 contained a $134.5M refund (+560 bps), a reversal of incentive compensation accruals (+40 bps of gross margin, plus SG&A), $13.4M of proxy-contest costs, and 20 bps of currency benefit. The table in Part 3 strips the refund. The other items are smaller but point in both directions.

Part 3 — Analyzing the financial statements

Dollars in millions except per share.

Americas comparable sales by quarter through FY2025 were −2%, −4%, −5%, and about −2% in Q4 (North America, per the Q4 call). Q4 briefly improved, then the trend broke sharply in 2026.

Guidance: set in March, cut twice

In under six months, the ex-refund EPS midpoint fell from $12.20 to $8.75, −28%. In March, management expected markdowns to decrease in the second half. They now expect them to rise 60 bps in Q3.

Q3 guidance:

• Revenue: $2.29–2.32B (−10% to −11%)
• North America revenue: down mid-teens
• Operating margin: about 6.5%, against 17.0% a year ago
• EPS: $0.93–0.98, against $2.59

The implied Q4 operating margin is about 19.8%, 250 bps below last year. The forecast assumes the holiday quarter holds up much better than Q3.

Diving deeper into Q2

Revenue missed; profit beat on costs.

Revenue came in $34M below the bottom of the three-month-old guide, and the whole miss was China. North America did slightly better than guided. The roughly $0.25 EPS beat came from lower incentive compensation (the CFO attributed 40 bps of gross margin to it) and cost actions. A profit beat funded by reversing bonus accruals does not repeat.

Is it seasonal? Q2 revenue is normally higher than Q1. Comparing the same Q1 to Q2 move a year earlier:

Three conclusions:

• Every region, channel and category fell short of its seasonal norm except "other channels," which is mostly outlets, wholesale and licensed stores: the lower-price, lower-control part of the business.
• China's sequential collapse is partly calendar. Chinese New Year moved into Q1 this year and added about 8 points to Q1 growth. Even adjusting for that, China fell well short of its norm. Year over year, which controls for the calendar, China fell 2% in constant currency.
• E-commerce fell as much as stores (−5.9% y/y against −6.5%). The weakness is not a store-traffic problem that digital can offset. Management said traffic and conversion fell in both channels.

Year over year, by category:

• Women's apparel: −3.8%
• Men's apparel: −0.5%
• Accessories: −13.4%

Management disclosed that leggings sales fell about 20% as demand shifts to looser "away-from-body" silhouettes. Total bottoms fell mid-single digits. Leggings were the franchise the brand was built on, and the replacement styles are "trending well" but not yet large enough to offset them.

Americas, excluding the refund. The Americas segment margin was reported at 36.8%, up 160 bps. The refund added 830 bps to the Americas' product margin. Stripped out, the segment margin was about 28.4%, against 35.2% a year ago. The segment that is two-thirds of revenue lost about 680 bps of margin in a year.

Part 4 — The standing issues, and how they evolved

On guidance

Two cuts in three months, the second larger than the first: the revenue midpoint fell $0.35B in June and $0.65B in September. The pattern matters more than any single number: management has not yet found the floor in its own forecast.

The CFO: "we expected a better response than we are seeing as we enter the second half of the year." And for the new guidance: "while our teams remain hard at work... we have not factored this potential into our financial outlook." The September guide is framed as conservative. The March and June guides were not, and both proved too high.

A new CEO arriving in September has an incentive to reset expectations low at her first full-year guide in March 2027. Treat FY2027 guidance as a separate event from the business trend.

On tariffs and the refund

• Paid: $230M of tariffs under IEEPA, the emergency-powers law the Supreme Court invalidated on February 20, 2026.
• Refunded in Q2: $134.5M plus $4.1M interest, worth $0.86 of EPS.
• Remaining: the 10-Q implies $95.5M. The CFO said "the remaining $105 million" on the call; the gap is not explained. Nothing further is in guidance and no asset is recognized.
• What is permanent: the removal of the de minimis exemption was upheld by the Court of International Trade on August 13, 2026. Most U.S. e-commerce orders ship from Canadian distribution centers and used to enter duty-free. That cost is now structural.
• Replacement tariffs: guidance assumes 10–12.5% through September and 20% after.

A new risk to the refund. Two consumer class actions (E.D. Michigan, March 27; W.D. Washington, June 30) claim the tariff-cost component of prices Lululemon charged customers, and "potential governmental tariff reimbursements." If they succeed, part of the refund belongs to customers, not shareholders. The company intends to defend both.

On the buyback

At today's price those 5.9M shares are worth $573M, $240M less than was paid. The share count fell from 116.5M to 110.7M in seven months (−5.0%), and remaining authorization is about $594M. Management says 2026 repurchases will be "in line with 2025" ($1.2B), which implies about $400M more by January.

Cash fell from $1.81B to $1.39B in the first half. First-half free cash flow was $312M against $695M of buybacks. The second half is seasonally the cash-generating half, but a $1.2B buyback is larger than the year's likely free cash flow after $690M of capex (FY2025 free cash flow was $922M, on much higher profits). The balance sheet can carry it (no debt, $594M of undrawn revolver). It is still a choice to shrink the cash cushion during a turnaround the company has not yet diagnosed.

Stock compensation is modest by comparison: $49.7M in the first half, about 1% of revenue, with $173.3M unrecognized over 2.4 years. Shareholders approved a larger equity-plan reserve in June. Dilution is not an issue here, unlike at many growth companies; buybacks run more than ten times SBC.

On inventory and markdowns

A genuine positive, and a contrast with 2024:

• Inventory: $1.71B, −1% in dollars and −7% in units.
• Reserves: rose to $99.5M from $88.8M, which is prudent.
• Chasing: management is reordering about 20% more volume in-season than last year and cut store SKU counts by 15%.

The watch item is how discounting is being delivered. Markdowns are up 70 bps in Q2 and guided up 60 bps in Q3, flat in Q4, and up 40 bps for the year. Separately, accrued credit-card affiliate liabilities nearly doubled to $118.2M. The 10-K groups this program with markdowns as a drag on product margin. A discount delivered through a card program does not show up as a markdown on the price tag.

On China

China carried the growth case: it was the reason the June 30 notes in this folder and Burry's June 24 piece could treat the Americas as a transitional problem.

Management's explanation: "spikes of negative commentary in the media and on social channels" at the end of Q1, compounded by the Great Wall of China event after the Q1 call. Burry's note records the controversy over the use of a Japanese war drum and the company's apology. Tmall also changed its 618 promotional event, and Lululemon chose not to follow with discounts.

The CFO: "we're not pointing to macro specifically as a key issue." A brand-sentiment problem in the highest-margin segment is harder to fix than a weak consumer. China still earns 37–40% segment margins and 15 new stores were added there in a year, so the fixed-cost exposure grew into the slowdown.

On the Americas

• Comparable sales: −12% in Q2, the worst in the company's recent history outside COVID.
• Q3 guide: North America revenue down mid-teens.
• Causes, per management: traffic, conversion and average order value all fell.
• Response: more marketing (SeaWheeze, the summer yoga series, creator content), fewer SKUs, more reordering into what sells, and store "premiumization" in a test group of doors.

Asked whether this is a traffic problem or a product problem, the CFO said "predominantly... traffic," with conversion negative but "not worsening." Marketing addresses traffic. The leggings decline is a product problem. Both are present.

On capacity

The company is still building, at a slower pace:

• Net new stores cut from 40–45 to ~35. About 10 are in North America (7 in Mexico), and about half of the North American openings are pop-up conversions.
• Pop-up stores cut from 65 to ~40 by year end.
• The multi-year distribution center project continues.

The return on that capital has fallen sharply. Net operating assets grew from $1.99B to $3.40B (+71%) between January 2024 and August 2026, while revenue grew about 8%. Part 7 shows the effect on returns. The FY2027 square-footage plan will be set in March, under the new CEO.

On governance and management

Management:

• CEO: Heidi O'Neill started September 8. Pay: $1.4M salary; 200% target bonus; about $10M a year in equity (60% performance units); $7.0M in sign-on equity vesting over two years; a $2.0M cash retention bonus. Severance is 24 months of salary plus full vesting.
• Interim co-CEOs: Meghan Frank and André Maestrini receive retention cash of $1.5M and $0.75M. It becomes payable at the earlier of the permanent CEO's start date or December 11, so it is now payable. Their retention equity keeps vesting if they are dismissed without cause within 12 months.
• Departures in ten months: CEO Calvin McDonald (January 31); Celeste Burgoyne, President Americas (December 31); Ranju Das, Chief AI & Technology Officer (August 13, disclosed in a two-sentence 8-K).

Board:

• 11 members after the June 25 meeting. New since March: Chip Bergh (ex-Levi's CEO), Esi Eggleston Bracey, and, under the Wilson cooperation agreement, Laura Gentile and Marc Maurer.
• A third Wilson-approved director with apparel expertise must be appointed by October 1.
• Declassification passed with over 99% of votes cast and takes effect at the 2028 meeting.
• Say-on-pay received only 63% support (46.4M for, 27.0M against).
• The proxy contest cost $24.8M in the first half.

Tax, new in this 10-Q. "In August 2026, the IRS withdrew from bilateral APA negotiations." The U.S.–Canada transfer-pricing agreement (an APA) expired in 2020 and had been under renegotiation since. Without it, the split of profit between the U.S. and Canada is exposed to audit. The 10-Q also notes new withholding taxes on Hong Kong earnings from 2026. Neither is quantified.

On insider activity and the founder

Open-market purchases in 2026, all at prices above today's:

Other insider activity:

• Sales: one small open-market sale (Chief Brand Officer, 622 shares at $161, April 8). Everything else in the Form 4s is grants and shares withheld for taxes.
• Trading plans: no officer or director adopted or ended a 10b5-1 plan in Q2.
• Other holders: the 2026 filings show Vanguard filing a 13G. Burry's note says Elliott owns about 5%; there is no Elliott 13D or 13G among the company's 2026 filings, so that is unverified.

The founder. Chip Wilson's group owns 9,570,851 shares, 8.6%.

• August 4: his foundation sold 5,713 shares at $122.56.
• September 1, two days before the Q2 print: his company LIPO entered a two-year prepaid variable share forward with Goldman Sachs on 1,274,318 shares, 13.3% of his stake and 1.2% of the company. It pledges the shares, allows LIPO to take cash prepayments now, and can be settled in cash. That lets him keep the upside, and it also lets him raise cash against the shares.
• The filing says it replaces a similar arrangement that expired in July, funds "ongoing investments that are not directly or indirectly related to" Lululemon, and "should not be interpreted as" a change in his investment thesis.

That is not evidence of anything improper. It is simply the kind of fact worth noticing: the largest individual holder raised liquidity against his shares immediately before a guidance cut.

On litigation

• Securities class action (Patel, S.D.N.Y.; class period December 2023 to July 2024): the motion to dismiss was granted in part and denied in part on March 31, 2026. The case proceeds.
• Derivative suits: stayed pending that case.
• Tariff class actions: the two consumer suits above.

None is quantified.

On the Burry thesis (June 24, 2026)

His structural points still hold:

• no debt
• tangible book of $41.58 per share, at 2.33× (his all-time-low reference is 2.14× in 2009)
• cash generation
• a brand still large enough to be the incumbent

What failed is the near-term evidence he pointed to.

Part 5 — What to watch in Q3 (reporting early December)

W1. Americas comparable sales. −3% (FY25), −6% cc (Q1), −12% (Q2). Guidance implies North America revenue down mid-teens in Q3. Anything better than −12% in comparable sales is the first evidence of a floor. Worse means the March 2027 reset will be larger.

W2. China constant-currency comparable sales. −8% in Q2. China plus Rest of World is guided +3–5% reported in Q3. Watch whether the November 11 (Singles Day) event performs "as normal," as management said it would. A second quarter of negative comparable sales in China means the brand-sentiment explanation is not temporary.

W3. Operating margin against the ~6.5% guide, with one-offs removed. Q2 contained a refund, an incentive-compensation reversal and proxy costs. The clean number is what matters.

W4. SG&A in dollars, not just as a percentage. The guide is +800 bps of deleverage. Management promised "a deeper look to rightsize the cost base." Cost actions that work show up as falling dollars, not a smaller rate of increase.

W5. Markdowns, and the credit-card affiliate liability. Markdowns are guided +60 bps. If the affiliate liability keeps rising while markdowns look contained, discounting is being delivered through the card program.

W6. The remaining IEEPA refund (~$95–105M) and the two consumer class actions. A second refund is upside not in guidance. A ruling for the plaintiffs would claw some of it back.

W7. Buyback pace against cash. About $594M of authorization remains. Watch whether the board adds more, and whether cash falls below ~$1B before the holiday quarter's cash arrives.

W8. The new CEO's first decisions. In rough order of importance:

• product leadership (the Chief Product Officer resigned in May 2024)
• whether the FY2027 store and distribution-center plans are cut
• whether the Q4 call "kitchen-sinks" FY2027 guidance

W9. The founder. The third director is due by October 1. Watch for any further 13D/A on prepayments under the Goldman forward.

W10. Net operating assets and sales per square foot. Capital grew 71% in two and a half years on 8% revenue growth. If square footage keeps growing ~10% while comparable sales fall, returns keep compressing regardless of margins.

Things we don't know:

• The absolute markdown rate. Only year-over-year changes are disclosed.
• Channel profitability. Store and e-commerce operating margins stopped being reported when segments moved to geography in FY2023.
• Leggings as a share of revenue. Only the −20% change was given.
• Traffic, conversion and basket size. Direction is disclosed; magnitude is not.
• Store-level economics. No four-wall margins, no cohort data behind the "one-year payback" claim.
• The rest of the IEEPA refund. Timing and amount are uncertain, and there is a $9.5M gap between the 10-Q and the CFO.
• The tax cost of the APA withdrawal. Not quantified.
• Elliott's stake. Reported by Burry, not visible in filings.

Part 6 — New CEO

Heidi O'Neill became CEO on September 8, 2026, announced April 22. Part 4 records her pay package; this part is about her record. Her integrity history is clean. The risk in this appointment is fit and inexperience.

N1. The direct-to-consumer pivot is hers. She ran Nike Direct and then Consumer & Marketplace through Consumer Direct Acceleration, the strategy of cutting wholesale accounts to sell direct. Nike has spent two years reversing it and rebuilding wholesale distribution. Lululemon's problem is product and Americas demand, not channel mix, so the credential the board bought is not obviously the one the company needs.

N2. Her last two years at Nike were the decline. She ran consumer, product and brand from May 2023 to May 2025. She did not run the company, but that is the period.

N3. Her exit was a role elimination. Nike's own exhibit describes "the elimination of the President, Consumer, Product & Brand role and your resulting transition," effective May 2, 2025, with a non-executive stay to September 5. She was excluded from the FY2026 bonus and long-term incentive plans, and her departure is treated as "an involuntary termination without Cause (or, as applicable, as a result of a Reduction in Force)" for equity purposes. Both sides are bound to non-disparagement. The public word was "retires."

N4. The headline credential is not verifiable. "Grew Nike from $9B to $45B" and "tripled the women's business" come from the appointment release and from profiles. Nike does not disclose women's revenue; the only figure on record is roughly $9B, from a December 2023 earnings call. Treat both as promotional.

N5. She was a defendant in Nike's securities case, and was dismissed. In re Nike, Inc. Securities Litigation (D. Or., 3:24-cv-00974) covers purchasers from March 19, 2021 to October 1, 2024 and alleges the company misrepresented the DTC pivot. On March 31, 2026 the court dismissed the claims against her, Friend, Campion and Parker; one Donahoe statement survived; Nike answered on May 29, 2026 and the case is in discovery. The allegations against her came from confidential witnesses and were found insufficient. The dismissal was without prejudice, so she can be named again in a further amended complaint, and she can be deposed.

N6. Her own money: clean. Her only Nike open-market sales were about $7.9M in 2021 (25,000 shares at $152 and 7,500 at $170 through 10b5-1 option exercises, plus 13,000 at $160.77 and 4,589 at $170), then one $1.0M sale in February 2025 at $71.18 under a 10b5-1 plan. Everything in 2022–2024 was share withholding for taxes. No pledged shares. She held roughly 110,000 shares through a 60% decline in the stock, which is not what selling into bad news looks like. At Skullcandy she bought 5,000 shares of her own in May 2015 at $8.28.

N7. No enforcement history. A full-text search of SEC filings on her name returns only her own Forms 3, 4 and 144, Nike proxies and Skullcandy filings. No regulatory actions, bans or disqualifications in public US records. Skullcandy was sold in 2016 at $6.35 against a $20 IPO in 2011, but she joined the board in August 2013, after that decline.

N8. She starts owning nothing. Her Form 3 shows zero shares on September 8. On September 9 she received 28,079 restricted units and 145,518 options struck at $99.72. Lululemon's guidelines require the CEO to hold 5× salary, about $7.0M, within five years, and to retain 75% of net shares until then. Nothing here is unusual, but no personal capital is at risk. Whether she buys shares on the market is the cheapest signal she can send.

N9. The market and the founder both objected. The shares fell as much as 12% on the announcement and about 15% over five days. Chip Wilson told shareholders a near-30-year Nike veteran is not the transformative, product-first leader the company needs; he settled his proxy contest on May 27 for two board seats and an 18-month standstill. Analysts split: Barclays called it an incremental positive with effects in 2027; William Blair called it out-of-left-field; BNP Paribas was disappointed; Needham called it intriguing.

What would change the read. A wholesale-led strategy shift in her first six months would confirm the Nike pattern. An open-market purchase of size, or a product-leadership hire of real weight, would argue the other way. She also keeps two public-company board seats, including an audit committee, while running a turnaround.

Part 7 — Valuation

Residual Operating Income valuation

Penman’s enterprise-side ReOI model, run off Net Operating Assets rather than earnings. Valuation date 2 August 2026. A trunk of shared facts and forecasts, then two branches that differ in one assumption.

Method: Stephen H. Penman, Financial Statement Analysis and Security Valuation: the Residual Operating Income (ReOI) model (Ch. 13–15), driven by Net Operating Assets and operating income after tax rather than by earnings.

Valuation date: 2 August 2026 (the latest balance sheet).

Prepared: 2026-09-10.

Sources: 10-Q Q2 FY26 (period ended 2026-08-02, filed 2026-09-03); FY2025 10-K; 8-K/earnings release 2026-09-03 (FY26 guidance); price $96.88, 10-year Treasury yield and beta regressions at 2026-09-10; Damodaran implied equity risk premium and industry betas, January 2026.

Why this model. Lululemon has positive earnings and book value, so the equity-side residual earnings model would also work. The enterprise-side ReOI model is used because it separates the operating business from $1.27B of cash, and because it shows where the returns are coming from.

Summary

Everything in this valuation is shared up to one question, and then it forks: a trunk of facts and forecasts common to both answers, then two branches that differ in a single assumption.

The fork: at the end of the forecast (FY2031) the model has Lululemon earning a 36.9% return on operating assets against a 10% cost of capital, a 26.9 percentage-point spread. Does that spread persist, or does competition erode it?

All values use a 10% cost of capital, derived in PART I, section 4, from a CAPM cost of equity of 9.2% with cash backed out; the derivation supports 9–11%. Branch B is adopted: competition erodes abnormal returns, and Lululemon’s moat is a brand, not a patent. Branch A is shown for contrast.

Three findings that survive whichever branch you pick:

1. The market price is reachable. $96.88 needs only $23.64 a share (24% of the market value) from the years after 2031. Justifying it requires a terminal pre-tax operating margin of 9.8% under Branch A or 13.7% under Branch B, against about 13.3% this year excluding the refund.
2. 76% of the market capitalization is already covered. Of the $10.73bn market value (110.71M shares × $96.88), net operating assets are $3.40bn, net cash $1.27bn, and the present value of residual income through FY2031 $3.44bn. Only 24% depends on the years after 2031.
3. The disagreement is the next two years of margin. The bear case is $75.76 under Branch B; the base case is $111.98. Q3 guidance (revenue −10% to −11%, a 6.5% operating margin) runs closer to the bear.

PART I — THE TRUNK

1. Reformulating the balance sheet

At 2 August 2026 ($ thousands):

For per-share figures, net financial assets are reduced by the $118.8M spent on buybacks between August 3 and August 28, to match the 110.71M share count at August 28.

A1. The capital base grew much faster than the business.

About 70% of the FY2025 increase came from inventory (+$259M) and the tax accounts: receivable +$170M, payable −$139M. Part of that is timing. The rest is stores, distribution centers and technology.

A2. Leases sit inside NOA. The $1.95B right-of-use asset and $2.14B lease liability are both treated as operating here. Rent stays inside operating income, so the treatment is internally consistent, but it has a consequence for the cost of capital: the lease leverage sits inside NOA, so the required return on NOA is higher than on a lease-free base (section 4). Treating the lease liability as financing instead (Penman's alternative) would enlarge NOA by ~$2.1B, lower the measured return to roughly 20%, and call for a lower rate. Done that way, Branch B comes out at $112.67 against $111.98 here.

2. Reformulating the income statement

RNOA = NOPAT ÷ beginning NOA = profit margin (PM) × asset turnover (ATO)

Both halves of the return are falling at once. Margin fell from 16.7% to 9.3% and turnover fell from 5.3× to 3.3×. The return on operating assets fell by about two-thirds in two years. At ~31% it is still about three times the 10% cost of capital: this remains a business that creates value. The direction is the issue.

3. The explicit forecast: H2 2026 – FY2031

The near term is the company's own guidance.

• FY2026 revenue midpoint $10.425B at a 14.6% operating margin (which includes the refund) implies H2 2026 revenue of $5,538M and operating income of $791M.
• Beyond that, a base case that assumes the decline stops:

Annualized. $ millions. ReOI and discount factors at the 10% cost of capital derived in section 4.

Assumptions:

• Revenue: flat in FY2027, then +3%, +4%, +4%, +4%.
• Operating margin: recovers from 13.5% to 17.0% by FY2031. That is about halfway back to the 20–24% of FY2023–FY2025; the de minimis cost is permanent, and fixed costs were built for a larger business.
• Asset turnover: 3.1× on beginning NOA.

The H2 2026 stub is charged half a year on the August NOA.

4. Cost of capital and other inputs

An earlier draft of this note used 9% as a judgment. It is now estimated from market data.

Cost of equity (CAPM): r_E = risk-free rate + β × equity risk premium.

From equity to operations. Leases are operating in this model, so the lease leverage is already inside both NOA and the equity beta. The only financial item to take out is cash, which earns the T-bill rate (3.85%) after tax:

r_F = (E × r_E − C × r_cash × (1 − t)) ÷ (E − C) = (10,726 × 9.17% − 1,271 × 3.85% × 0.7) ÷ 9,455 = 10.0%

Cash earns less than the business, so the operating business net of cash is riskier than the equity: r_F sits above r_E. With the equity valued at about $112 instead of the market price, the rate would be 9.9%.

Range. A beta of 0.95–1.08 gives 9.8–10.4%. An equity risk premium of 5.0% gives 10.9%. Built bottom-up from industry betas and relevered for Lululemon's leases, apparel peers give 8.8% and specialty retail 9.8%. The regressions are noisy (R² 0.13, standard errors near 0.3), so the base is rounded to 10.0%, with 9–11% as the range.

Cross-check. Treating leases as financing requires a lower rate on a larger base: 8.75% on NOA plus lease liabilities, with lease interest at the 4.4% discount rate disclosed in the 10-K. Branch B then comes out at $112.67, against $111.98 below. The two treatments agree once each uses its own rate. The earlier 9% was close to the right rate for that treatment, applied to this one's base.

• Tax: 30%, the company's FY2026 guidance.
• Stock compensation is expensed, as reported. At ~1% of revenue it is not a swing factor.
• Shares: per-share values use the 110.71M shares outstanding at August 28. Adding unvested RSUs and PSUs (1.05M) lowers each value about 1%. Options average a $258.81 strike and are far out of the money.

5. What the trunk settles

$73.24 is the floor of the base case: the balance sheet plus five and a half years of forecast, with nothing assumed after 2031. The market price of $96.88 needs only $23.64 per share (24% of the market value) from the period after 2031. Most of Lululemon's price is covered by assets and near-term profits. That changes where the argument is.

PART II — THE BRANCH POINT

At the end of the forecast the model has Lululemon earning RNOA of 36.9% against a 10% cost of capital: a 26.9-point spread, producing ReOI of $1,048M in FY2031. The question is what happens to that spread.

ReOI = (RNOA − r_F) × NOA

The spread half-life is the number of years it takes for the advantage to fall by half. A half-life of H years is an annual persistence factor φ = 0.5^(1/H). ReOI then grows at φ × (1 + g) − 1, with NOA growing at g = 3%.

φ = 0.5^(1/H)  ·  g_ReOI = φ × (1 + g) − 1

CV_2031 = ReOI_2031 × (1 + g_ReOI) / (r_F − g_ReOI)

• half-life = ∞ → the spread never fades → Branch A (φ = 1.00)
• half-life finite → the spread erodes → Branch B (φ < 1.00)
• half-life = 0 → Penman’s Case 1: the operations are worth their book value at the horizon, and the answer is the trunk’s $73.24

PART III — BRANCH A: the spread persists

Branch A: the spread persists (φ = 1.00; Penman Case 3, g = 3%).

53% of the value is in the continuing value.

Sensitivity ($ per share)

PART IV — BRANCH B: the spread fades

Branch B: the spread fades, with a 10-year half-life (φ = 0.933).

35% of the value is in the continuing value.

The full family:

Scenarios

The bear and bull cases use the ends of the 9–11% cost-of-capital range.

Sensitivity ($ per share)

The market price equals Branch B at a 12.1% cost of capital, above the top of the 9–11% range the derivation supports.

PART V — CHOOSING BETWEEN THEM

Choosing between them

Branch B, for three reasons.

1. Penman puts the burden of proof on persistence. Abnormal returns attract competition; permanence needs affirmative evidence.
2. The moat is a brand, not a patent. The company's own 10-Q says its fabrics "generally are not patented and can be imitated" and warns about "dupe" products. Brands can last decades, but branded apparel has a long record of fades (Gap, Abercrombie, Under Armour), and Lululemon's core product, leggings, is declining 20% a year right now.
3. But Lululemon has shown persistence before. Returns stayed well above the cost of capital through its 2013–2017 crisis (per Burry's ROIC chart), and the business is still earning ~31% on operating assets at its current low point.

A 10-year half-life respects that record without assuming it lasts forever. Seven years would be too short for a 25-year-old global brand. Twenty would ignore what is happening to leggings.

What the market must assume

For comparison: FY2026 ex-refund margin is ~13.3%, and FY2023–FY2025 averaged 21.9%.

The market is not pricing a collapse. It is pricing a Lululemon whose operating margin settles around 13.7%, roughly this year's level, and stays there. Alternatively, it is pricing a recovery combined with an advantage that halves every 4.7 years. The no-recovery scenario under Branch B ($85.21) sits below the market.

So the disagreement is not about the tail. It is about the margin over the next two to three years, which is observable every quarter:

• If FY2027 stabilizes and the margin starts back toward 15–17%, the shares are worth ~$112, and up to ~$126 if the advantage lasts twenty years.
• If the decline continues into FY2027 at anything like the Q3 run-rate, the bear case ($75.76) is the relevant number, and it is below today's price.

Where the model is weakest

M1. The base forecast assumes the decline stops in FY2027. Q3 is guided at −10% to −11% revenue and a 6.5% operating margin. The explicit forecast has FY2027 revenue flat at a 13.5% margin. The current quarter resembles the bear case more than the base. The trunk's $73.24 rests on that forecast.

M2. NOA includes $480M of tax receivables and nets $2.1B of leases against $1.9B of lease assets. The tax receivable has nearly tripled since FY2024. If some of it is a disputed position, and the IRS's August withdrawal from APA talks raises that possibility, it is not an operating asset that earns 10%.

M3. The cost of capital rests on noisy inputs. The beta regressions have an R² of 0.13 and standard errors near 0.3, and the equity risk premium is January's. Branch B moves from $121 at 9% to $112 at 10% and $97 at 12%. The derivation supports 9–11%; the market price needs about 12%.

M4. The remaining tariff refund is excluded (~$95–105M pre-tax, ~$0.60 per share after tax), as are the claims in the consumer class actions and any outcome of the securities case.

M5. Buybacks are treated as neutral. The model values the operations and adds cash. The ~$400M of further 2026 buybacks management expects creates value only if the shares are worth more than the price paid. The $814M spent so far this year was at an average price 42% above today's.

Conclusion

Lululemon is worth about $112 per share on a base case that assumes the decline stops next year, against a market price of $96.88. The plausible range is $76 to $126, and the low end is the current trajectory.

What the model establishes regardless of branch:

• The business still earns about 31% on net operating assets, about three times its 10% cost of capital. It creates value. That is not in question.
• But both profit margin and asset turnover are falling: margin from 16.7% to 9.3%, turnover from 5.3× to 3.3×, as capital grew 71% while revenue grew 8%.
• $73.24 per share is covered by the balance sheet and five and a half years of forecast. The market needs only 24% of its price from beyond 2031, so the terminal assumption is not where the risk sits.
• The market price is consistent with an operating margin that settles around 13.7%, about this year's level, and never recovers.

The most defensible summary is a condition, not a target. Lululemon is cheap if the Americas decline finds a floor within the next two or three quarters and the margin begins to recover from ~13%. Every data point in the Q2 filing on that question pointed down: comparable sales, China, markdowns, and guidance. The balance sheet, cash flow and inventory pointed up. The new CEO's first two quarters are the test, and her first full-year guidance in March 2027 is likely to be set low.

Part 8 — What-If Financial Simulator

Penman Residual Operating Income (ReOI) interactive model · Enterprise side · Driven from operating margin or from business drivers · Balance sheet as of 2 August 2026