Lululemon's Gross Profit Margin Is Looking the Part

Shareholders who seek to evaluate fashionable yoga-wear manufacturer and retailer Lululemon Athetica (NASDAQ: LULU  )  have numerous factors to consider. Not only did the company recently hire a new CEO, Laurent Potdevin, but it announced a $450 million share buyback program and updated investors on its growth plans for the current fiscal year.

While these announcements sent the company's shares to their lowest level in years, they aren't the only drivers of the company's overall business. Shareholders have numerous other factors to consider, including return on equity, sales growth, and perhaps one of the most important for retailers -- gross profit.

The scoop on the gross profit margin
Gross profit for a retailer, or any other business, is simply what remains after subtracting the cost of goods sold from net revenue. The measure ignores things like selling, general, and administrative expenses, depreciation, interest expenses, or any one of numerous other costs a company might incur in its day-to-day operations.

Looking at a company's gross profit margin and which way it is headed can be very telling. It lets Foolish investors know what type of business they are dealing with (a discounter or a premium brand), and also lets them know what to watch out for. After all, any profitable business with a huge gross margin is bound to have imitators.

Stacking up to the competition
There have been a lot of changes at Lululemon recently. All of them are important in evaluating Lululemon's business. Lululemon's gross margin is essential in assessing how much the company secures from every dollar of sales after it accounts for the cost of that good. So how does Lululemon stack up to a few other big retailers?

Company Name

FY 2011

FY 2012

FY 2013

Lululemon Atheltica

56.9%

55.7%

52.8%

The Gap

36.2%

39.4%

39%

Ross Stores

27.5%

27.9%

28%



Clearly, shareholders in Lululemon Atheltica are dealing with a premium retailer. Its gross margin is astronomical, not only on its own, but also in comparison with those of competitors The Gap (NYSE: GPS  ) and Ross Stores (NASDAQ: ROST  ) . The Gap has been included in this company comparison because its subsidiary Atheta directly competes with Lululemon, and its creation occurred because executives over at The Gap saw the profit relished by Lululemon.

Ross Stores serves as a solid contrast with Lululemon. Ross Stores seeks to buy fashionable merchandise at a discount and sells this merchandise to customers at a discount as well. Lululemon, with its $82 Luon pants, represents the other end of the retail spectrum from Ross Stores.

What is potentially troubling about the gross profit margins of these three very different companies is the trend at Lululemon. Both The Gap and Ross Stores are holding steady on their gross profit margins, while Lululemon's gross margin seems to be slowly trending downward. This could be a major cause for concern, depending on the reason for the decrease. So should shareholders worry that Lululemon's most profitable days are behind it?

Thankfully, the answer appears to be 'no.' Within the company's latest annual filing, Lululemon gave two reasons for the decrease: (1) a decrease in product margin of 200 basis points due to a lower sales mix of higher-margin core items related to the pull-back of black Luon pants, and (2) a non-recurring charge of 110 basis points related to the pull-back of black Luon pants in the first quarter of fiscal 2013.

Clearly, the company's gross margin decrease in fiscal 2013 resulted primarily from Lululemon's well publicized "Luon pants debacle" and not because it had to discount ALL of its products in order to bring in customers. While there are no guarantees, it seems likely that Lululemon's profit margin will likely hold up for the foreseeable future.

Foolish takeaway
Lululemon is definitely a unique brand with a very healthy profit margin. This large profit margin has led to imitators that seek to cut in on the company's business, such as The Gap's Athleta brand, but this has not forced Lululemon to discount its product in order to generate sales. Lululemon Athletica may have numerous problems to contend with, but its gross profit margin is not one of them. Foolish investors would be wise to keep this information in mind when deciding whether or not Lululemon would benefit their portfolios.

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12/18/2014 4:04 PM
GPS $41.01 Up +0.60 +1.48%
Gap CAPS Rating: ***
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ROST $92.71 Up +1.94 +2.14%
Ross Stores, Inc. CAPS Rating: ****

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