Lululemon Soars After Earnings: Time to Buy?

Lululemon surged higher on Thursday after reporting better-than-expected earnings: Is it the right time to buy the stock?

Mar 27, 2014 at 10:12PM

Lulu

Source: Lululemon

Lululemon (NASDAQ:LULU) surged by 6.16% on Thursday after the company delivered better-than-expected earnings for the fourth quarter of fiscal 2013. The company seems to be gradually recovering from past mistakes and getting ready to refocus on growth opportunities. However, competitive pressure from players such as Gap (NYSE:GPS) and Under Armour (NYSE:UA) is materially increasing, and Lululemon will need to improve its performance in order to justify current valuation levels.

The numbers
Net sales during the quarter ended on Feb. 2 came in at $521 million, a 7% increase versus $485 million in the same quarter of the prior year, and better than the $514.9 million forecasted on average by Wall-Street analysts.

The direct-to-consumer segment was particularly strong with a 25% annual increase, and reaching $97.8 million during the quarter. This represents 18.8% of total revenues. On the other hand, comparable-store sales decreased by 2% on a constant-dollar basis.

Margins were under pressure during the quarter. Gross profit margin decreased to 53.5% of sales versus 56.5% in the fourth quarter of fiscal 2012, and operating margin fell to 29.6% compared to 31.4% in the year-ago quarter.

Earnings per share were flat versus the prior year at $0.75, but above analyst's forecasts of $0.73 on average.

Forward guidance was below estimates, though. The company is forecasting sales in the range of $377 million to $382 million during the first quarter of fiscal 2014, compared to an average estimate of $389.4 million. Earnings-per-share guidance of between $0.31 and $0.33 also fell short of analysts' expectations for the coming quarter, in the area of $0.38 per share.

CEO Laurent Potdevin seems quite optimistic about the company´s growth prospects in the middle term. He said that, "2014 is an investment year with an emphasis on strengthening our foundation, reigniting our product engine, and accelerating sustainable and controlled global expansion."

The challenges
Lululemon made a series of embarrassing mistakes last year. In March of 2013, the company had to recall 17% of the yoga pants it had in stock because of excessive sheerness. However, this did not provide a definitive solution to quality problems, as the company received further criticism and complaints from customers regarding product quality during the following months.

Making things worse, founder and former chairman Chip Wilson made some very inadequate 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.

Competitors have not wasted any time in trying to benefit from Lululemon's mistakes. Gap is directly targeting Lululemon with its Athleta yoga brand, placing its Athleta stores in close proximity to Lululemon locations, and selling its products for considerably lower prices.

Athleta is also imitating Lululemon's marketing strategy by building relationships with yoga instructors and sponsoring workshops, classes, and similar activities to build brand awareneess.

Under Armour took advantage of Lululemon´s sheerness problems by launching a marketing campaign for its yoga pants under the slogan: "We've got you covered." Like Lululemon, Under Armour is trying to position itself as a brand that can be used for both the gym and other everyday activities.

In the words of CEO Kevin Plank, "One of the reasons we are so bullish on our Women's business is that there has been a quiet shift going on, where women are increasingly wearing athletic product outside of the gym."

Valuation vs. growth
Lululemon seems to be stabilizing after its recent mistakes, and it will be interesting to watch the company as it expands internationally. Lululemon will open its first store in London next week. If the brand does well among consumers in global markets, it could provide considerable opportunities for growth in the years ahead.

On the other hand, the stock looks too expensive for a company that is still trying to definitively turns things around. Lululemon carries a P/E ratio near 27 times earnings during the last year. That´s more expensive than industry leader Nike (NYSE:NKE), which trades at a P/E ratio near 25.

Nike is much bigger than Lululemon, but the company is still generating superior growth rates with sales increasing by 13% during the quarter ended on Feb. 28, to almost $7 billon. Besides, Nike owns arguably the most-recognized brand in the industry, and it has a much wider customer base on a global scale.

Unless Lululemon manages to materially accelerate growth, an alternative like Nike looks like a sounder option for a similar valuation.

Bottom line
Lululemon seems to be moving in the right direction, and stabilizing sales could be the first step to getting over its problems and accelerating growth in the future. However, in terms of valuation versus financial performance, investors could find a stronger alternative in an industry leader like Nike.

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Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica, Nike, and Under Armour. The Motley Fool owns shares of Nike and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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