On Tuesday, Lululemon Athletica (LULU -0.88%) stock gained 4.3% on a day when the market was down, continuing its post-earnings-release run. On Friday, shares of the athletic-wear retailer jumped 6.7%, following the company's release of a fiscal second-quarter report that delighted investors. (The U.S. stock market was closed on Monday for the Labor Day holiday.)
Lululemon's quarterly revenue and adjusted earnings per share (EPS) surged 29% and 33%, respectively, year over year. Both results sped by Wall Street's consensus estimates. Moreover, management raised its full-year guidance for the top and bottom lines. It now expects annual revenue growth of 26% to 27% and annual adjusted EPS growth of about 26%.
This type of growth for a retailer would be robust in any macroeconomic environment. But it's particularly a standout for a discretionary-products retailer in the current environment, which includes high inflation and continued global supply chain problems stemming from the pandemic.
Earnings releases tell only part of the story. Following are key points investors should know about the company's supply chain that management discussed on the second-quarter earnings call.
How supply chain woes are improving
From CEO Calvin McDonald's remarks:
[L]ike others in the industry, we continue to navigate challenges throughout the supply chain. That said, we are pleased to see some promising signs of improvement yet recognize further normalization within the supply chain will take some time. We currently have no closures across our vendor base.
There are several reasons the company's supply chain woes are easing up. First, as McDonald mentioned, none of Lululemon's suppliers are currently closed. That contrasts with the first quarter and into the second quarter when some Chinese vendors were forced by the government to close certain operations because of upticks in COVID infections.
Second, ocean delivery times are improving relative to recent quarters, but they're still "significantly elevated compared to the pre-COVID period," according to McDonald. This improvement means that the company hasn't needed to use expedited shipping (which is via air and more expensive than ocean shipping) to the same degree that it had been. Moreover, while air freight rates are still quite elevated relative to the pre-pandemic period, they've started to come down, McDonald said.
Quantifying the improvement in the supply chain
From CFO Meghan Frank's remarks:
[W]e are starting to see higher on-time deliveries from our vendors, as well as some shorter [ocean] lead times. So we have amended the color that we provided on air freight to be 10 basis points under last year for the full year. [T]hat compares to 30 basis points above that we previously guided to.
Let's unpack this statement. Earlier in the year, management said that it expected air freight expenses to hurt product gross margin for fiscal year 2022 (which ends Jan. 29, 2023) by 30 basis points (0.3 percentage points) relative to fiscal 2021. Now it is projecting that air freight expenses will provide fiscal 2022 with a very slight boost (0.1 percentage points) to product gross margin relative to last fiscal year.
The better news is that there is much more room for improvement because air freight expenses were also notably elevated (pardon the pun) in fiscal 2021. As Frank put it, "We still see air freight as an opportunity over the longer term. It still sits 280 basis points [2.8 percentage points] above 2019," or before the pandemic started.
As to the ocean shipping lead times (lead time in this context usually refers to the time from booking freight to the receipt of goods): On average, Lululemon's ocean freight lead time is now about 70 days. This number peaked at about 90 days. But there's still room for significant improvement, since the company's pre-pandemic average was about 45 days.
Don't get hung up on the above numbers. They simply support the main takeaways:
- Lululemon's fantastic quarterly results are even more impressive than they might seem because the company is still grappling with supply chain issues that are denting its profitability.
- The company is poised to get a tailwind as its supply chain continues to strengthen.