Lululemon Athletica (LULU 0.05%) stock just took another leg(ging) down during the second week of 2023. Since the start of 2022 just over a year ago -- what I'll loosely call the start of the current bear market -- shares have lost just over 20% of their value. The most recent reason for the market's pessimism toward Lululemon?
Some analysts seem to be concerned that Lululemon resorted to heavy discounting during the recently wrapped holiday shopping season, oftentimes a sign of excess inventory and weak demand. Other retailers have been telling such a tale as consumers deal with elevated inflation, a faltering economy, and rising interest rates from the Federal Reserve.
But before panicking, let's dig into the numbers, because this could merely be another buying opportunity for this top athleticwear stock.
Heavy discounting? Please ...
A few months ago, I compared Nike's ballooning inventory with that of Lululemon's. For Nike, global supply chains started to unthaw at exactly the same time its customer base started to get cautious. To burn off the excess, Nike had to get busy discounting -- which means lower profit margins. Lo and behold, that's exactly what transpired during the swoosh brand's last quarter. Revenue grew, but profit didn't budge much, due to higher sales but at lower prices.
By contrast, Lululemon's inventory was stretching its legs as it made up for shortfalls in 2021 (thanks again, supply chains). Its brand and apparel lineup (shoes for women and more clothes for men, for example) is also expanding quickly, especially internationally, so I predicted discounting wouldn't be an issue during the holiday shopping season.
In a recent update to its fiscal 2022 fourth-quarter earnings guidance, Lululemon management seemed intent on proving me wrong. Or were they? The previous outlook called for year-over-year gross margin improvement to about 58.3% to 58.4% (compared with 58.1% last year). Now, the outlook for gross profit margin has been lowered to 57.0% to 57.2%. In tandem with this update, revenue guidance was actually increased by about $50 million and is now expected to be in a range of $2.66 billion to $2.70 billion -- representing year-over-year growth of 25% to 27%.
The market interpreted this news as the typical result of increased discounting, and Lululemon stock fell nearly 10% in response to management's update. More sales but at a lower margin must mean Lululemon started slashing prices, right?
But the market could use some more clear-headed time on its yoga mat, because a mere one-percentage-point drop in gross margin on a mere $50 million increase in the sales outlook (up less than 2% from the prior guidance) could hardly be construed as "heavy discounting activity."
After all, other forces are in play here. As CFO Meghan Frank explained during the previous earnings update in early December, the economy is dynamically changing from week to week. A strong U.S. dollar, which reduces the value of an international sale, might be the actual problem. Lululemon is growing rapidly overseas, so more-than-expected growth in a market outside of the U.S. could be the culprit.
Frank explained that the timing of supply chain investments might also cause a slight gross margin dip. Then, there's also the simple fact that normal levels of discounting are coming back after nearly two years of constrained inventory. Perhaps that normalization to pre-2020 pricing strategies came just slightly quicker than previously thought.
Either way, Lululemon's numbers are knocking the socks and tracksuits off of the competition. This company has top-tier gross margins, discounting or not.
Data by YCharts.
Focus on brand power over the long term
Also interesting in the company's financial update was that earnings per share (EPS) guidance was narrowed, not reduced. The expectation is now for EPS to be in a range of $4.22 to $4.27 for the fiscal fourth quarter, compared to the previous range of $4.20 to $4.30. If you're keeping score, EPS was $3.36 in the prior-year period. Despite "lowered" gross margin guidance, EPS should still rise 26% year over year.
Whatever the reason for gross margin taking a step back during the holiday shopping frenzy, Lululemon was able to compensate with lowered operating expenses. Management is clearly warmed up and executing at a high level.
Basically, if you thought Lululemon stock was a fair purchase a couple of weeks ago, not much has changed after the market's little panic following the company's slight quarterly guidance adjustment. Now, that's not to say things couldn't get worse. It appears many retailers had a disappointing closeout to 2022, and the pain could carry over into the new year as well. For now, though, Lululemon is still on track to meet its long-term expansion goals. If you've been looking for an opportunity to buy, now might be it.
