Lululemon Athletica (LULU 0.05%) has a lot of inventory on hand, which normally would be a red flag for any retailing business. That risk is even more elevated at a time when economic growth rates are slowing and inflation is spiking.
However, the apparel retailer isn't as exposed to inventory writedowns as you might think. Strong demand trends through the first part of 2022 also imply Lululemon is striking the right balance in keeping its shelves fully stocked.
Let's take a closer look.
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Good growth
The main reason not to worry about stockpiling inventory is that growth trends have rarely been better. Lululemon notched a 32% spike in sales through the selling period that ended on May 1, trouncing expectations for the second straight quarter. For context, Nike reported 9% revenue growth in its core U.S. market through late February.
Lululemon's business is riding several positive trends, including a flood of hit product releases and its push into new demographics and geographies. Its athletic and leisure apparel is striking a chord with online shoppers, too, which accounted for nearly half of overall sales.
In that context, it makes sense that inventory would rise 74% year over year to $1.28 billion in the fiscal first quarter. Management is rebuilding inventory (compared to a slump last year) while working to secure more products, so it doesn't have to rely as much on expensive air freight transportation.
The Lululemon difference
It's also notable Lululemon doesn't carry as many seasonal items as other retailers like Target and TJ Maxx. That setup means investors can worry less about the promotions and writedown charges that hurt Target's 2022 earnings outlook. "Our primary focus on technical athletic apparel mitigates the need for mark downs," CEO Calvin McDonald said in a recent conference call with investors.
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That success allowed Lululemon to maintain its industry-thumping profitability level. Operating margin held steady in the latest quarter and is sitting well above peers like Nike. Sure, Nike is more exposed to the Chinese market, which slumped recently due to pandemic restrictions, but Lululemon has a brighter earnings outlook overall, partly because of its success in the e-commerce channel.
Looking ahead
Management said in early June they weren't concerned with the inventory buildup, which they described as a planned process. "While our levels are higher than our historical norms," McDonald said, "we are comfortable with the quality and composition of our inventory."
Investors will have to wait and see if management's inventory bet pays off with the first evidence arriving with the retailer's next earnings results in early September.
Striking the right balance would likely mean Lululemon outpaces the growing athleisure industry in both sales and profitability. The wrong call by the management team would show up most clearly in falling gross and operating margins through the summer months.
