Lululemon Crashes: Should You Buy?

lululemon athletica (NASDAQ: LULU  ) was plunging by more than 16.5% on Monday after the company cut its sales and earnings forecasts for the fiscal fourth quarter. The market tends to overreact to negative announcements, and uncertainty usually creates opportunity for investors. On the other hand, the company has made a series of expensive mistakes lately, and competitors like Gap (NYSE: GPS  ) and Under Armour (NYSE: UA  ) are stepping up their efforts to gain market share in the lucrative yoga apparel market.

Take a deep breath
Lululemon cut its sales guidance for its fiscal fourth quarter ending Feb. 2 to between $513 million and $518 million, versus a prior range of $535 million to $540 million. Earnings per share guidance was also reduced to between $0.71 and $0.73, compared to a previous guidance of between $0.78 and $0.80 per share.

According to CFO John Currie, sales and traffic figures during January are coming in lower than the company anticipated:

We were on track to deliver on our sales and earnings guidance through the month of December; however, since the beginning of January, we have seen traffic and sales trends decelerate meaningfully. Based on this recent performance and assuming these trends continue through the remainder of January, we are reducing our outlook for the fourth quarter...

Upside down
Lululemon has made a series of expensive mistakes in the last year. In March, the company had to recall 17% of the yoga pants it had in stock because of excessive sheerness. This did not provide a definitive solution to the problem, though; customer complaints regarding product quality and poor customer service are still an issue for the company.

Adding insult to injury, founder and -- now ex -- chairman Chip Wilson made some very unfortunate comments insinuating that women's bodies may be to blame for the problems with the company's products. "Frankly, some women's bodies just actually don't work," Wilson said on Nov. 5 in an interview with Bloomberg TV.

Understandably, this has produced further disappointment and even infuriation among Lululemon's customers. Wilson has apologized and resigned the chairman position after the scandal, but it certainly has not helped Lululemon or its image among customers.

For a company like Lululemon, which sells high-priced products at a steep premium to competing alternatives, these kinds of mistakes can have serious consequences in terms of reputation and brand value. Especially if they become a recurring issue for the company, customers could easily turn to other brands.

An uncomfortable position
Competition in the yoga business has been increasing lately, and players like Gap and Under Armour, among others, are more than happy to capitalize on Lululemon's mistakes to gain market share in the segment.

Gap's Athleta yoga brand is becoming a direct challenge for Lululemon. Gap is opening new Athleta stores near existing Lululemon locations, benefiting from its traffic and undercutting Lululemon products in price by a considerable difference. Gap is also imitating Lululemon's marketing strategy by hooking up with yoga instructors and sponsoring all kinds of classes and similar activities to increase brand awareness.

Athleta offers a wider variety of sizes than Lululemon, providing an alternative for customers who prefer a more inclusive brand -- and capitalizing on Wilson's unfortunate comments.

Under Armour is also stepping up its efforts in women's apparel; CEO Kevin Plank believes women's apparel will generate around $1 billion in revenue for the company in 2016, and yoga could be a considerable opportunity for Under Armour in the coming years. Under Armour is clearly going after Lululemon with its marketing campaigns; the company recently launched a big campaign for its studio yoga line using the tagline "We've Got You Covered," in clear reference to Lululemon's sheerness problem.

Considering its innovative drive and reputation for quality when it comes to fabrics and designs, competition from Under Armour represents a material risk for Lululemon in the middle term.

Lululemon has been one of the most successful brands in the sports apparel business over the last several years, but success attracts competition, and the company is now facing serious pressure while at the same time it struggles to leave its quality problems in the past and repair its image.

Bottom line
Every business has its ups and downs, and exaggerated price fluctuations can be a source of opportunity for long-term investors. However, it's hard to tell at this stage if Lululemon's problems are simply transitory, or if competition is making a permanent dent and affecting the company´s pricing power and growth prospects for years to come. Lululemon's visibility problems go well beyond its pants. 

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Comments from our Foolish Readers

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  • Report this Comment On January 13, 2014, at 6:56 PM, tdotsports1 wrote:

    Buy $UA on this weakness...

  • Report this Comment On January 14, 2014, at 8:05 AM, drax7 wrote:

    Yoga people are so fanatical about their religion, that fat people are discourage not to buy their clothing. It's the other way around, the CEO did not make a mistake at all, your analysis is dead wrong.

    Yoga fanatics will continue to buy lulu stuff just because the obese are not welcome.

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Andrés Cardenal

Andres Cardenal, CFA is a tenacious researcher of the best investment opportunities around the world. Andres is an economist and CFA Charterholder living in Buenos Aires, Argentina. Naturally flavored. Follow me on Twitter for more investment ideas:

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