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Lululemon Turns a Tidy Profit in a Terrible Quarter

By Demitri Kalogeropoulos – Jun 14, 2020 at 4:00PM

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But spiking inventory levels could spell trouble for the second half of the year.

The COVID-19 pandemic hurt just about every aspect of lululemon athletica's (LULU 0.73%) business over the last few months. Store closures pushed revenue lower and sent expenses rising as a percentage of sales, the apparel specialist revealed in its first-quarter earnings report this week.

But unlike many of its peers, Lululemon reported only a modest overall sales decline as customers embraced its online sales channel. The company managed to earn a profit during the historically difficult selling environment, too.

Let's dive right in.

Group of women holding a yoga pose.

Image source: Getty Images.

Protecting the sales base

As expected, sales trends were much worse than the 20% spike Lululemon posted just before the novel coronavirus outbreak disruptions started in mid-March. Revenue fell 17% to $652 million.

But that growth figure reflects expanding market share and impressive momentum. TJX Companies, for example, reported a 53% revenue decline at its apparel segment over the same period.

The difference was Lululemon's digital sales channel, which already accounted for 29% of overall revenue before the crisis hit. The chain's customers seamlessly moved most of their demand to that division when its stores closed. As a result, Lululemon's digital sales rose 70% to account for 54% of the business.

Staying profitable

The retailer endured major cost pressures in the period, with gross profit margin worsening to 51% of sales from 54% a year ago. Extra expenses amplified that shortfall, leading to a 75% drop in operating income. Yet Lululemon still managed to generate a profit. Net income landed at $29 million compared to $97 million a year ago. That's a welcome surprise considering that most industry peers reported significant losses due through the COVID-19 store closures.

Lululemon also avoided significant writedown charges, which implies that its booming e-commerce sales channel allowed it to continue selling seasonal merchandise. "Our strong digital business demonstrates the strength of our guest connection," CEO Calvin McDonald said in a press release, "and the long-term opportunity to create further Omni-[channel selling] experiences going forward."

Looking ahead

One potential red flag is the fact that inventory jumped 41% in the period, which could mean major writedown charges or profitability declines over the next few quarters. Management isn't worried about this scenario, though, because nearly half of its product portfolio is what they call "core product" that isn't dependent on a particular season.

Executives said in a conference call with investors that they see "limited markdown risk" for their merchandise holdings today. "We are positioned well from an inventory standpoint," McDonald explained, "and maintain an ability to react to multiple demand scenarios."

The uncertain path of the virus, plus the recessionary growth environment in key markets like North America and Europe, still has Lululemon declining to offer its customary short-term sales outlook. But management did say that they see its slumping sales pace moderating in the second quarter before returning to growth by the end of fiscal 2020. Meanwhile, the digital business is on track to expand by more than 100% in Q2.

Lululemon predicted that inventory growth will continue outpacing sales for the next few quarters, in part because the company doesn't want to put too much financial pressure on its suppliers. Investors will learn whether that gamble paid off by following the chain's gross and operating profit margins through early 2021.

Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Lululemon Athletica. The Motley Fool recommends The TJX Companies. The Motley Fool has a disclosure policy.

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