The Underlying Reasons for Lululemon's Fall

Lululemon's stock decline had been predicted two months ago because of poor competitive positioning in a maturing market and the first-quarter conference call validated this argument.

Jun 25, 2014 at 5:30PM

The recent stock price decline of Lululemon Athletica (NASDAQ:LULU) catalyzed by poor future guidance has illuminated issues that have been clear for awhile. The company's deficient competitive positioning, including its lack of patents in a maturing women's apparel market, has and may continue to keep margins lower than they were in previous years. Foolish investors should be wary of Lululemon, especially as the CEO's conference call comments show that the company lacks a strong strategy to combat the consumer preference for its lower-margin products.

Previous analysis
The Motley Fool article titled "Gross Margin Decline at Lululemon has just begun" written two months ago explained that the company's success has prompted competitors to enter the market, and is starting to put pressure on its premium pricing. Its lack of a sustainable competitive advantage will likely result in a lower gross margin. Since Lululemon owns no patents or intellectual property rights for the technology, fabrics, or processes underlying its products, competitors can manufacture and sell similar products at discount prices.

Lululemon's e-commerce sales growth strategy will catalyze a gross margin decline because the Internet makes product comparisons easier for direct-to-consumer and in-store sales. The women's branding strategy will likely pigeonhole the company as it tries to diversify deeper into male product markets.

Conference call catalyst
The recent first-quarter conference call validated my expectations as Lululemon dialed back its gross margin guidance, and the stock dropped 16% in a single day. Gross profit for the first quarter came in at $195.7 million or 50.9% of net revenue, compared to 170.7 million or 49.4% of net revenue in the first quarter of 2013. The 1.5% increase was largely assisted by the 5.1% improvement to the Luon write-off from last year. The abysmal 3.1% product margin decline shows that Lululemon's high-margin items continue to sell poorly. It seems improbable that Lululemon can get back to its mid-50s gross margin on a long-term basis.

At this point, it seems clear that Lululemon has a dilemma. It either has to offer product discounts on its high-margin products, or sell its lower-margin products. Lululemon's strategy to combat this negative outlook, discussed on the conference call, is simply to "operate more efficiently and just work with our factory partners". While this overgeneralized solution may help on the cost side, it does not solve the problem that customers are buying fewer high-margin products.

In fact, when CEO Laurent Potdevin  was asked about the company's customer preferences, he responded:

We've actually never used a lot of data in the history of Lululemon. And as far as looking at consumer sentiment brands strengths, we actually just launched -- we implemented NPS, Net Promoter Score, and we got our first benchmark yesterday. So I haven't had a chance to fully dig into them. But I am really looking forward to using that as a tool to sort of see where our brand initiatives are, changing the brand sentiments and improving conversion and traffic.

For the CEO of a women's apparel company to state that it has no relevant data on consumer sentiment is shocking.

CFO retirement
If the outlook wasn't poor enough, on June 12, 2014, the company announced that CFO John Currie intends to retire by the end of the fiscal year. At the age of 57, it's questionable if Mr. Currie is retiring for what he called "flexibility to take full advantage of the west coast lifestyle that I so enjoy on the water and on the slopes", or to leave a company with poor competitive positioning.

Foolish takeaway
Lululemon's poor competitive positioning within the women's apparel market is subject to the vicissitudes of consumer fashion trends. As the brand fails to extract premium pricing like it did in years past, its margins will fall. The CEO's comments on the conference call should worry Foolish investors that the brand value may fall sooner than later. Even though the stock price decreased significantly, which has attracted some buyers, it still looks like a Lemon.

Leaked: This coming device has every company salivating
The best investors consistently reap gigantic profits by recognizing true potential earlier and more accurately than anyone else. Let me cut right to the chase. There is a product in development that will revolutionize not just how we buy goods, but potentially how we interact with the companies we love on a daily basis. Analysts are already licking their chops at the sales potential. In order to outsmart Wall Street and realize multi-bagger returns, you will need The Motley Fool’s new free report on the dream-team responsible for this game-changing blockbuster. CLICK HERE NOW.

christian sgrignoli has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers