lululemon's Revenue at Risk in Product Recall

Yogawear retailer lululemon athletica (NASDAQ: LULU  ) announced that it would be pulling some of its core products off the shelf based on concerns about product quality. The company announced that its pulling some of its black Luon pants -- the company's iconic yoga pants line -- after it determined that a recent shipment was too sheer. The pants account for 17% of the company's total inventory of women's bottoms, and the recall is going to hit the bottom line in a big way.

Through the announcement of the recall, lululemon was on track for an 11% increase in comparable store sales. That was already a drop from the 18% increase seen in the third quarter, and on Friday, investors will hear how the fourth quarter turned out. But the shortage is going to hammer those sales, driving comparable growth down to between 5% and 8%. That's a huge fall, and it opens up lots of opportunities for competitors to move in on the valuable turf.

Waiting in the wings
The two biggest threats to lululemon have to be Gap (NYSE: GPS  ) and Under Armour (NYSE: UA  ) . Gap is pushing hard for growth in its Athleta line, and the company has said that it plans to almost double the number of Athleta stores this year from 35 to 65. Gap sells a similar yoga pant for women that retails for 15% to 20% less than the lululemon line. The brand has seen excellent growth over the past year, and a month without competition from lululemon could make a huge impact on the brand's revenue for the quarter.

At every possible opportunity, Under Armour has said that it plans to grow its business into a more gender-balanced model. The ultimate goal is to get an even revenue split from its men's and women's lines. This is a chance for Under Armour to push its range of yoga and studio pants, which cost about as much as Athleta's pants. For Under Armour, the opportunity comes at an excellent time, as the company has announced plans to front-load its 2013 marketing campaign, meaning that it has the capability to really jump on lululemon's setback.

Still waiting
Those are opportunities that neither company can afford to just let slip. lululemon has estimated that the shortfall is going to result in a $12 million to $17 million decline in revenue in its first quarter. If Gap picked up those sales, it would be about a 13% increase in revenue for its Athleta segment over the last quarter. For Under Armour, the company has said that women's apparel accounts for about 30% of the total apparel revenue. Last quarter that would have been about $120 million. Adding over 10% to that line this quarter would be fantastic. Here's the thing -- neither brand seems to have made a big move.

Remember when the lights went out at the Super Bowl and Oreo made waves with one, little tweet? That's the sort of thing that should be happening at Gap and Under Armour. That's taking advantage of the situation and making the most from a competitor's weakness. As of midday on Tuesday, neither brand had tweeted, posted to their Facebook page, or put their yoga lines on the front of their websites. I'm going to go ahead and say that's money lost.

The cycle repeats
Setting aside competitors for a moment -- as it seems like they've set themselves aside -- let's look at one more troubling issue. This isn't the first time lululemon has had inventory problems. Over the last few years, the company has swung between too little and too much product. Investors should be concerned about the follow-on effects of this snafu. With bad press and limited core inventory, customers will cut down on visits to the store, which means other products will linger as well. That's going to come back to bite lululemon in the next quarter, when it has excess inventory in other lines.

The bottom line for investors is all bad news. The stock has fallen 9% over the past two days, and with more details coming out on Thursday's call, there could still be a little way left to fall. The company is still trading at a P/E near 40, which is well above the sector average of 20. Investors considering a change of heart might look to the equally expensive, but stronger Under Armour, or Gap, which is much cheaper, P/E-wise. 

If lululemon athletica can get its inventory in line, it has the potential to grow its sales at a crazy rate. But without question, the competitive landscape is starting to increase. Can lululemon fight off larger retailers like Gap and Under Armour, and ultimately deliver huge profits for savvy investors like yourself? The Motley Fool answers these questions and more in our most in-depth lululemon research available for smart investors like you. Thousands have already claimed their own premium ticker coverage, and you can gain instant access to your own by clicking here now.


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