Why Lululemon's Buyback Plan Is a Bad Idea

Lululemon reported disappointing first-quarter results and slashed guidance for 2014. Its stores are struggling, and competition from Gap is causing trouble. The $450 million buyback plan announced by the company is not the solution.

Jun 26, 2014 at 5:30PM

The bad news keeps on coming for athletic-apparel company lululemon athletica (NASDAQ:LULU). The company's first-quarter results were disappointing, guidance was slashed, it was announced that the CFO is planning to leave the company, and Chip Wilson, former CEO and owner of 27% of Lululemon's shares, recently called out board members publicly for only focusing on short-term results.

A $450 million buyback was also announced, funded with repatriated cash, but based on the market's reaction, investors weren't thrilled. A growth company like Lululemon should be plowing its earnings back into the company, not buying back its own shares, and the move reeks of desperation. Wilson just might have a point.

Things are still getting worse
During the fourth quarter, total comparable-store sales, which include online sales, rose by 4%, while comparable-store sales excluding online sales fell by 2%. At the time, management guided for an improvement over the course of 2014, expecting total comparable-store sales to rise in the low- to mid-single digits for the full year.

This guidance was cut to just low-single digit growth after the company reported its first-quarter earnings. This may not seem like much of a cut, but it means that the best-case scenario is now that sales at the stores themselves, excluding online sales, still decline. In the first quarter, total comparable-store sales rose by 1% but declined by 4% when online sales are excluded. Lululemon is not expecting its stores to show growth in 2014, and that's a big problem.

The athletic-apparel market grew by 8% over the past year, according to NPD. While Lululemon managed to grow total revenue by 11% year over year in the first quarter, this was mainly the result of opening new stores. In existing markets, Lululemon significantly underperformed the industry, and that means that those sales went to competitors like Gap's (NYSE:GPS) Athleta.

Gap is rapidly expanding the Athleta brand, with plans to open 35 locations this year, pushing the total store count above 100. Gap doesn't break down Athleta sales directly, combining it with other small brands Piperlime and Intermix, but collectively these three brands grew revenue by about 24% year over year during the first quarter.

Much of this is the result of growing the number of stores, and it's difficult to determine exactly how existing Athleta stores fared. But given Gap's planned store- count increase of more than 50% this year, I think it's safe to say that things are going well.

Why a buyback is a bad idea
Retail is a difficult business, and coupled with changing fashion trends and fickle customers, the apparel-retail business is doubly difficult. Retailers of all shapes and sizes will eventually need to weather a storm, be it a recession or a temporary loss of interest in the brand, and having a fortress balance sheet is a good way to make sure that short-term problems don't kill the company.

Lululemon's $450 million buyback seems reckless; propping up the per-share earnings during difficult times is not worth weakening the balance sheet, and the $30.9 million the company spent in taxes to repatriate the cash needed for the buybacks is an expense that didn't need to happen.

Lululemon management should be focused on fixing the problems at the company's stores. Instead, they're engaging in short-term financial engineering in order to make the company's results not look as bad. The stock is near its 52-week low, but it still trades at 20 times earnings, a lofty multiple for an apparel retailer struggling to grow comparable-store sales. Shares of Lululemon aren't cheap, they just appear that way because they were so overpriced in 2013.

In 2013, Lululemon's return on equity was 25.5%. This means that for every dollar that Lululemon invested into growing the company, an additional 25.5 cents of earnings was generated. Compare this to the 5% earnings yield that is represented by a P/E ratio of 20, and it's clear that this buyback is not the optimal use of cash. There are two possibilities here. One, management may not be confident that this high level of ROE is sustainable, and that may mean that the days of rapid earnings growth are over. Or two, management is simply attempting to give the stock price a short-term boost. Either way, it's bad news for long-term shareholders.  

This isn't to say that Lululemon can't recover, and the company can certainly keep opening new stores. The activewear industry is worth about $31 billion annually, and Lululemon has only $1.6 billion in annual revenue. Lululemon's high prices relegate the company to a fraction of this market, but there is still plenty of room to grow. If stores continue to be weak, however, expenses are going to rise faster than revenue, much like what occurred during the first quarter, and the company's lofty margins will be at risk.

The bottom line
Lululemon's buyback plan is a bad idea given the problems that the company is facing, and it will weaken the balance sheet at a time when the brand is struggling. Investors are right to be upset with Lululemon, and the former CEO has a point when he claims that management is too focused on the short term.

While investors may be tempted by the stock sitting well below the highs of last year, Lululemon has yet to prove that it deserves its current valuation, let alone a higher one. At 20 times earnings, and with earning per share guided to decline in 2014, shares of Lululemon are priced much like the products that it sells.

Warren Buffett's biggest fear is about to come true
Warren Buffett just called this emerging technology a "real threat" to his biggest cash-cow. While Buffett shakes in his billionaire-boots, only a few investors are embracing this new market which experts say will be worth over $2 trillion. It won't be long before everyone on Wall Street wises up, that's why The Motley Fool is releasing this timely investor alert. Click here to learn more about what's keeping Buffett up at night and the one public company we're calling the "brains behind" the technology.

Timothy Green 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information