Why Investors Should Avoid Lululemon

Yoga apparel retailer lululemon athletica (NASDAQ: LULU  ) thoroughly underwhelmed the market this week when it announced its fourth-quarter results. The company's comparable-store sales growth fell, and it announced that it was projecting a fall in earnings per share in the coming quarter. That drop will largely be due to the recent recall that the company issued after it discovered that a series of its products were too sheer for customers' tastes.

The stock was down on the earnings news and, added to the drops from earlier in the month, helped pull the stock down 19% since the beginning of 2013. That means the company is also down over the past 12 months, with investors growing weary of product setbacks, slow international expansion, and shrinking comparable sales growth. Lululemon is looking like an increasingly dangerous recommendation, and investors would be better served moving on to greener pastures.

The year in review
This time last year, Wall Street couldn't get enough of Lululemon. The company was coming off a 100% share-price increase over the previous 12 months, with all sorts of plans for the coming year. It was going to open 37 new stores, including locations in New Zealand and Australia, and keep gross margin above 55% -- it did that. It was planning to hit earnings per share of $1.50 to $1.57 -- it hit $1.85. It even planned to fix its inventory problems -- that only kind of worked out.

There's the rub. Lululemon didn't manage to stop itself from hurting itself. The company said in its call last year that it wanted to "enter 2012 with a strong inventory position to break the cycle of chase." It did that, in that it managed to keep enough stuff in stock over the course of the year to sell it all. But early this month, we found out that there were new problems on the horizon. The reason Lululemon is having a hard time of things isn't that it had a really bad 2012, but that it's already having a bad 2013.

Recall, if you will, the promises made
Lululemon's earlier problem now pales in comparison with the new one. Back then, the company was running out of clothing to sell because it had planned poorly. That's not great, but it indicates how popular the company had become, and the fact that you couldn't get the items drove interest in them. The new problem is a PR nightmare -- clothing that you bend and twist in that loses its opacity when it's stretched. All the good work that Lululemon did over 2012 to make sure it had the right amount of product in-store got thrown out the window when huge chunks of that product became worthless.

Companies such as Gap (NYSE: GPS  ) and Under Armour (NYSE: UA  ) are waiting in the wings for the sorts of missteps that could bring Lululemon down. Missteps like releasing clothing that you can see through. Lululemon has estimated that the shortage is going to cost it $7 million to $17 million.

Sales slow
The more troubling thing, from my perspective, is that in the last quarter, comparable sales grew by only 10%. That might sound great for another company -- Gap's sales grew only 5% last quarter -- but it's not great for Lululemon. It was a quarter of slowing of growth in a year that averaged an increase of 16%. The company has also forecast an even greater fall this coming quarter, with comparable sales growing in the high single digits. That's a hard knock to shrug off, and it's going to be even more difficult if the company can't get past its quality issues quickly and cleanly.

Those problems -- quality, inventory, and sales -- combine to make Lululemon a risky proposition, in my mind. The company trades at a heavy premium that puts it in the P/E range of Under Armour. But right now, it has a plethora of downsides and very little light at the end of the tunnel. Sure, international expansion could be excellent, but investors have been waiting for at least two years to see meaningful international growth -- how much longer do they need to wait?

For the foreseeable future, I'm going to steer clear of Lululemon and stick with either Gap or Under Armour. Both companies are expanding and making changes to their businesses that look like good long-term decisions. Also, since this is the last line, insert your own joke here about transparency in business.

Can Lululemon continue to fight off larger retailers such as Gap and Nordstrom and ultimately deliver huge profits for savvy investors, or is it doomed to a slowdown? The Motley Fool answers these questions and more in our most in-depth Lululemon research available for investors. 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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Comments from our Foolish Readers

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  • Report this Comment On March 23, 2013, at 4:52 PM, cyberkid88 wrote:

    I wish that you as consistent in your postings. Seems different posters have different views on Lulu.

  • Report this Comment On March 23, 2013, at 5:17 PM, TMFPennyWise wrote:

    Andrew, Thanks for your LULU comments.

    I happen to agree that LULU better watch her back--I think GPS's Athleta is going to do an end run, given the transparency misstep--a retailer that charges as Lulu does can't really make those mistakes--BTW, I have read that now LULU expects $50 M in costs associated with the recall. Ouch!

    I love Lulu's fashion/style and buy their clothes (when I'm feeling rich and reckless) but I don't think I'd buy the stock (even when I'm feeling rich and reckless).

    Andrew, also, thx for writing all the other articles about retail stocks--I appreciate hearing your point of view. Jay

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