People who plan to own a stock for the long term should be investing based on the company's fundamentals. If those fundamentals deteriorate, that's a signal that it's time for you to reevaluate whether you should keep owning those shares.
So when Lululemon Athletica (LULU 1.74%) announced its third-quarter results on Dec. 8, something caught my eye: the retailer's growing inventory levels. That metric made me stop, think, and reconsider whether my underlying assumptions about the company were wrong -- or at least, in need of an update.
Image source: Getty Images.
Inventory has nearly doubled this year
As anyone who's ever run a retail business knows, managing your inventory can be tricky. A business must keep product levels high enough to meet customer demand. But if it stocks too much and winds up stuck with oversupplies of goods, it can be left cutting prices to clear out the excess.
LULU Inventories (Quarterly) data by YCharts.
As the above chart illustrates, Lululemon's inventory skyrocketed this year -- from $966 million in February to $1.7 billion by October, an increase of 80%. By contrast, its peers Nike and Adidas only grew their inventory levels by 21% and 26%, respectively.
So should investors be worried about it? I say no, because of Lululemon's secret weapon: pricing power.
Gross margins are still outstanding
In retail, pricing power is everything. If you can charge high prices and still grow your sales, your business will thrive. And that's precisely the position Lululemon is in. Its products are popular, well-made, and relatively expensive. Because of that, Lululemon boasts some of the highest margins in retail.
LULU Gross Profit Margin (Quarterly) data by YCharts.
Compared to Adidas and Nike, it's clear that Lululemon is the winner on this front. The company's gross margins have averaged 56% over the last three years, compared to 50% for Adidas and 42% for Nike. What's more, Lululemon achieved those margins while growing its revenue by 28% year over year.
Is Lululemon still a buy?
Lululemon remains a buy for me because it has shown no signs that it's losing its pricing power. I stopped by one of its stores just this week to see for myself. Men's running shorts were listed for $88; the asking price for a fetching "Wunder Puff" vest was $268.
While I passed on both the shorts and the vest, I came away convinced that this apparel company's pricing power (and therefore its margins) remain as strong as ever. As I am a long-term Lululemon shareholder, that keeps me from worrying about its growing inventory.
