Is a Beaten-Down Lululemon Athletica a Good Investment?

Lululemon shares have crashed after the sheer-pants controversy, but the company is trying to turn around. Is Lululemon a buy yet?

May 12, 2014 at 5:48PM

It has been more than a year since athletic-apparel and yoga-wear company lululemon athletica (NASDAQ:LULU) recalled its see-through yoga pants. Lululemon's stock price has taken a massive beating to the tune of 35% since March 2013 when the sheer-pants controversy reared its head, and things haven't improved so far. In addition, Lululemon's uneventful analyst day seems to have diffused investors' enthusiasm.

With competition rising from the likes of Under Armour (NYSE:UA) and Gap's (NYSE:GPS) Athleta brand, Lululemon will find the going difficult in the future as it tries to turn around its business. However, the company is indeed taking some steps toward improvement. Let's see if Lululemon can succeed in its efforts and if it is a buy at current levels.

Aiming for a turnaround
On analyst day, Lululemon CEO Laurent Potdevin announced that the company is ambitiously looking to tap the men's activewear market. Lululemon believes that its men's business will be worth $1 billion in sales in the next few years, although no definite timeline was provided. However, the good thing is that this target far exceeds the $200 million estimate that Wall Street analysts had assigned to Lululemon's men's business. 

In addition, Lululemon is trying to turn around its women's business. The company launched a new clothing line, known as &Go, that can be worn all day long, whether in a gym or at a club. Lululemon is trying to strengthen its foundation by rejuvenating its product line besides seeking international expansion opportunities.

The company is seeing an increase in demand from Asia and Europe, which is why Lululemon will open more stores in Asia, where it already has six locations. Also, Lululemon is in the process of recruiting a general manager for its Asian operations. This shows that it is serious about expansion in the continent, and its development in the region should pick up pace once there's a dedicated executive in place.

In Europe, Lululemon recently opened its first store in London. The company generated a strong buzz around the brand by hosting a yoga event at the Royal Opera House. More than 9,700 people turned up for the event, but there were only 350 spots. This shows the company's strong marketing activities and brand equity. Encouraged by the response that it received, Lululemon has decided to open its second store in London by year-end.  

Also, Lululemon is working on improving its product mix. The new chief product officer is aggressively examining every aspect of product improvement, with a focus on both seasonal and core products. Lululemon has seen terrific demand for seasonal products in North America of late, as they are selling at four times the anticipated rate. Clearly the company can be expected to focus more on this category. 

Strong competition
However, the worrying factor for Lululemon is its negative same-store sales, or comps, performance. In the fourth quarter, comps were down 2%. Lululemon has struggled on this front since the sheer-pants controversy, which gave an opportunity to peers such as Under Armour and Gap to eat into Lululemon's market with their own products.

Under Armour tried to make the most of Lululemon's blunder last year by promoting its UA StudioLux Quattro collection aggressively. As pointed out by Fool contributor AnnaLisa Kraft, Under Armour reportedly has a budget of $250 million for women's advertising. Moreover, it might be possible that Under Armour was able to woo customers away from Lululemon by advertising that its yoga pants never pill. So, Under Armour is a potent threat that Lululemon needs to watch out for.

On the other hand, Gap has made the most of Lululemon's quality issues. Gap has been trying to take market share from its rival for a couple of years, opening its Athleta locations alongside Lululemon stores. In addition, Lululemon's yoga pants cost $30 more than pants at Gap's Athleta. The difference between the material used in making both is almost negligible, but Lululemon does provide a hidden waistband pocket, as pointed out by Business Insider. Hence, paying a $30 premium for Lululemon's pants might not make sense to customers and could lead to price cuts.

Final words
Lululemon is facing some big obstacles, but the company isn't losing hope. It sees 2014 as an investment year and expects to come out stronger as a result of its aggressive strategies and improved product mix. Moreover, with analysts expecting the company's earnings to grow at a compounded annual growth rate, or CAGR, of almost 17% for the next five years, there's a possibility that Lululemon's situation will improve going forward.

Also, the stock's decline seems to have opened up a good opportunity for savvy investors who might consider adding more shares to their portfolio since Lululemon trades at just 19 times forward earnings.

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Amal Singh has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica and Under Armour. The Motley Fool owns shares of 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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