In the first quarter, lululemon athletica (LULU 1.07%) continued to experience low traffic, which has plagued a lot of brick-and-mortar retailers lately. But there were some positive signs -- such as higher gross margin, strong customer response to new products, and strong growth in international markets -- that should be encouraging to investors.
Margins firm up
While stores have struggled with low traffic, Lululemon has made up for it with higher product margin and higher average retail prices. Excluding costs associated with the restructuring of the ivivva business, adjusted gross margin improved 210 basis points year over year to 50.4% in the first quarter. For the second quarter, management expects a further increase in adjusted gross margin of 100 basis points as a result of product margin improvements.
Lululemon's Metal Vent Tech men's top. Image source: Lululemon.
Higher product margin is a result of investments the company has made the last few years to improve its supply chain. Management is continuing to look for ways to improve materials sourcing to respond to customer demand faster. The result of these improvements is more reliable materials sourcing for the design teams, assisting their innovation efforts, as well as allowing the company to fill gaps in style and color when needed.
New products generating positive customer reaction
Building on the revamped supply chain effort is the introduction of new styles hitting stores that are scoring wins with customers. Lululemon's recent product launches have been receiving a strong customer response in important categories like men's bottoms and women's sports bras. Women's bras have been an area of weakness for Lululemon, but strong demand for the new Enlite bra seems to have turned that weakness into a strength.
Lululemon's Enlite sports bra. Image source: Lululemon.
Management has found that a significant number of customers who have bought the new Enlite bra have not previously bought a bra from Lululemon, and they see this as an opportunity to reach a broad range of new customers. On the first-quarter earnings call, CEO Laurent Potdevin described Enlite as "creating a significant halo across the category."
The successful launch of Enlite is even more significant when considering it's the most expensive bra Lululemon sells at $98. When Lululemon uses its technical design strength to maximum effect, creating a product like Enlite or the men's ABC pants, that has the right fabric, fit, and comfort, customers will pay up for it. This is where Lululemon shows its brand power, and if the design team can keep this up, the company will have no problem returning to growth mode.
In addition to Enlite, the Nulu and Nulux fabrics continue to be a hit with women as well, and these were the key drivers for women's bottoms comparable-store sales performance in the first quarter.
The men's category, which is 20% of Lululemon's revenue, continues to perform well with high-single-digit comparable-store sales performance during the first quarter despite facing a tough comparable of more than 20% growth in the year-ago period. Men's bottoms, which are typically the introductory product to the brand for men, generated a robust 20% comparable-store sales growth in the first quarter, which bodes well for short-term growth in the men's business.
Overall, total men's comparable-store sales grew in the low double digits in the quarter, and for the second quarter, Lululemon launched new running tops -- Pack 'N Dash and a new Metal Vent Tech style -- to keep the momentum up.
International growth opportunity
Finally, it's important to point out that while Lululemon's largest market (North America) has been sluggish, Asia has been completely opposite for Lululemon. Newly opened China stores are generating a phenomenal $1,600 in annual sales per square foot. Management is capitalizing on this robust demand by accelerating store openings in major cities, such as Xintiandi and Shanghai.
Outside of Asia, London was a bright spot, with 50% sales growth in the recent quarter. Management estimates Lululemon's international opportunity at $1 billion, representing about 43% of 2016 total revenue, with Asia having the most growth potential.
The Foolish bottom line
Given these positive trends in gross margin, recent product launches within important categories, and international growth, investors shouldn't give up on Lululemon just yet. While I don't expect Lululemon to return to the high growth rates of the past, double-digit earnings growth is very doable, and that's all that is needed to get the stock moving higher.
