Earlier this week, I wrote an article explaining why I liked lululemon athletica (NASDAQ:LULU). In summary, it has broad appeal, strong sales growth, and geographic and consumer expansion on the horizon. But now Credit Suisse analyst Christian Buss has downgraded the stock because of three hurdles that he saw lululemon having a hard time with.
First, there was concern that the crazy-high same store growth the company has seen is dropping off. Second, competitors are moving in on lululemon's turf, which is going to lead to a host of problems. And finally, the company was going to have its historically high margins knocked down, as it has had to put more items on sale recently.
Here's why I'm not overly worried.
Before we even get into the specifics, let's make one thing clear: Of course Lululemon is going to slow down at some point. It's theoretically impossible to continue growing as fast as it has, forever. The question we need to ask is, "Will the slowdown come sooner rather than later, and will it be significant?" Buss is most worried about the older stores in the chain, which have been open for five years.
The fallback in sales at these stores will probably start to show this year. But investors don't need to worry as much as Buss would have us believe. Last quarter, comparable sales increased 18% compared with 2011. In the same quarter the previous year, comparable sales were up 16%. The rate was increasing last quarter.
But that doesn't mean they'll continue to increase. To figure out what's going to happen, we need to look at the environment that Lululemon is currently competing in.
First of all, competition has certainly increased since this time last year. Gap (NYSE:GPS) is pushing its less expensive Athleta line hard as it chases Lululemon's customers and store footprint. Under Armour (NYSE:UA) has said it's going to actively pursue the women's market in the coming years, which will surely include more products geared toward Lululemon's core customers .
As I said before, I think increased competition is a very good thing for Lululemon. Right now, a pretty basic pair of its yoga pants costs about $100. At Target (NYSE:TGT), I can get yoga pants for $10. Lululemon suffers from being the expensive place to get things. As competition increases, and Gap's $75 pants or Under Armour's $60 version become the norm, $100 will still seem pricey, but not ridiculous.
While that competition builds and customers become accustomed to the price of high-end yoga pants, Lululemon will probably see sales dip. The answer to this fall is already being formulated in the company's expansion of its men's and running lines. Those will help bring new customers into the store, including customers who are already used to the higher-priced running-product environment. With that move, any major downturn should be muted.
Finally, Buss worries that Lululemon is using promotions more than it used to and discounting goods to lower price points. But that's actually a good thing. In previous years, the company wasn't producing enough product and was losing sales because of its empty shelves. Now, it's holding on to more than it needs, to have inventory to discount at key points in the year .
While anecdotal, a quick look at the company's website shows that I can buy outerwear at a good discount but that most core items are only lightly on sale -- about 25% off. As long as the company maintains its pricing strength in its core lines, I see no reason to worry about major margin compression. As John Kernan, an analyst with Cowen & Co., put it, Lululemon achieved such a high margin in its earlier performances that it would have to operate perfectly not to see margins fall a bit. But it's nothing to be overly concerned with, and the rumor of falling margins certainly doesn't justify the 5% fall the stock suffered yesterday.
The bottom line
Lululemon is a strong brand with high pricing power, a well laid out expansion plan, and good products. If it goes through any sort of slowdown, it will be just that -- a slowdown. The company itself is diversifying to ensure that it's a going concern for years to come, and investors would be wise to think about picking up this excellent stock on its current downturn. At least look into it before you buy one analyst's sky-is-falling scenario.
Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends lululemon athletica and Under Armour and owns shares of Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.