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It's great for a company to be transparent, but lululemon athletica (NASDAQ: LULU ) has taken it to a whole new level. Last week, the yogawear retailer recalled more than $60 million worth of pants that were deemed too see-through to be sold in stores. The reason for the problem was a super-sheer fabric called luon, which is found in 17% of the retailer's yoga pants.
CEO Christine Day bluntly addressed the situation by saying "the truth of the matter is that the only way that you can actually test for the issue is to put the pants on and bend over." It might sound funny, but this joke might majorly dent the company's income. Can Lulu redeem itself, or is it stuck in "downward facing dog" for good?
Namaste will never be the same
Day's comment was a quotable sound-bite for the news media to gobble up, but it also proved that Lululemon has glaring issues in its quality-control practices. If the company's chief seller is yoga apparel, then why shouldn't it be putting the pants on and bending over? This kind of inspection -- testing the product for errors before putting it up for sale -- is vital for a quality brand, whether it's a computer, a hamburger, or a pair of stretchy pants.
According to Lululemon's recent 10-K, the apparel business partners with a leading independent product testing company that checks for "pilling, shrinkage, abrasion resistance, and colorfastness." After what could be a $60 million error, Lulu might add "sheerness" to that list.
The damage is so clear, it's see-through
When news broke of the recall, Lululemon's stock took a 5% nosedive from just over $65 to just under $62. Before that, the company's finances had performed pretty well -- in 2012, its annual revenue jumped 37%, passing the $1.3 billion mark.
Retailers generally struggle to keep up margins, but Lulu still managed a net profit margin of 19.7% last year, and an operating margin of 28%. On top of larger revenue, the company was able to boost the efficiency of its production.
As for PE, Lulu rings in at 33.5, which is close to the industry average of 33.7 and squarely in between the ratios of its peers. The much larger Nike (NYSE: NKE ) clocks in at a much smaller 23.1, while the smaller Under Armour (NYSE: UA ) has the largest at 41.5.
Now for the cold light of day: In 2012, Lululemon brought in a net income of $271 million. If the sheerness glitch had happened that year, it would have eaten away 22% of its total net profit. This is a mistake that simply can't happen again for Lulu, and investors can only hope that the expense and negative publicity will make the company tighten up its inspection guidelines.
Can Lululemon fight off larger retailers such as Gap and Nordstrom, and ultimately deliver huge profits? 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.