2014 Will Be a Good Year for Lululemon as Women Get Active

Lululemon (NASDAQ: LULU  ) has been a tough apparel retailer for investors to own over the last year. Holding the stock got even tougher this week when Lululemon offered some insight into its performance so far this year.

The stock fell off a cliff after the update, dropping as much as 15% in a day. Lululemon provided an outlook for January traffic and sales that showed these numbers had decelerated meaningfully in comparison with December. As a result, the company slashed its fourth quarter earnings per share guidance range to $0.71-$0.73 from the previous $0.78-$0.80.

This could still be a chance to buy into Lululemon in preparation for a strong 2014. ITG's channel checks showed that Lululemon is actually tracking ahead of consensus estimates for its fourth quarter sales. Although Lululemon's store traffic has been weak so far this year, its same-store sales would actually have been positive if they included e-commerce.

The Lululemon brand continues to resonate with consumers. Its premium brand was expected to see some trade-down, but this has yet to happen. As noted at the ICR Xchange Conference, consumer research shows that Lululemon still tests very positive for brand loyalty. Lululemon also has unrivaled design and quality over major peers. The company has had a number of hiccups, but it continues to conduct brand perception surveys and the brand is resonating with an increasing number of consumers. It changed suppliers after its latest quality control incident and implemented a new program that randomly rewards its customers with "random acts of kindness," such as trips. 

The market continues to heat up for women's athletic and yoga-focused apparel. The GAP (NYSE: GPS  ) launched Athleta to compete with Lulu, and Nike (NYSE: NKE  ) is also looking to get deeper into the women's business.

However, Lululemon continues to be the leader when it comes to flows to the bottom line. That is, Lululemon has some of the best margins in the business. Lululemon's net profit margin over the trailing twelve months is above 18%, while Nike's is 1% and Gap's is 8%.  

Both Gap and Nike are much more than women's apparel companies. While Lululemon can focus on making the shopping experience better for women, Nike has to worry about its core business, shoes, and Gap must manage its various brands -- Old Navy, The Gap, and Banana Republic.

While Gap has been orchestrating an impressive turnaround since 2004, it's still got a long way to go. This includes catching up with other retailers in e-commerce and getting its international growth plan on track. Given the questions about the retailer, it trades rather cheap at less than 15 times earnings. On a positive note, Gap does have a relatively low PEG ratio at 1.1 and it could surprise investors if it had a better holiday season than they expected.

The one positive about Nike is that it already has a presence in emerging markets, namely China. Lululemon is still a U.S. operator with over 90% of its revenue tied to the U.S. One the flip side, some of Nike's biggest struggles have been in China. During Nike's fiscal first quarter it saw revenue down 3% year-over-year in China, with footwear sales down 7%.

Bottom line
Lululemon is expected to grow EPS by an impressive 18.4% per year over the next five years. Meanwhile, The Gap is expected to grow at 13.5% per year and Nike at 12.3% per year. Lululemon is trading around $47 per share and it has yet to recover from its pants debacle. Its short interest is still relatively high at 20%, which means the results of a solid fourth quarter could lead to a short squeeze. 2014 should be a great year for Lululemon investors. 


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