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There's a Silver Lining to Lululemon's Plunge

By Steve Symington - Dec 13, 2013 at 1:30PM

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Shares of lululemon athletica dropped 11% Thursday. Here's why long-term investors shouldn't be worried.

Image source: lululemon athletica.

As if lululemon athletica (LULU 5.20%) investors hadn't had a tough enough year already, shares of the athletic apparel specialist plunged more than 11% Thursday following the release of its third-quarter financial results.

But that's not to say Lululemon's Q3 numbers were terrible. To the contrary, quarterly revenue rose 20% year over year to $379.9 million, which translated to 15.4% net income growth to $66.1 million, or $0.45 per diluted share. Meanwhile, analysts were looking for earnings of $0.41 per share on sales of just $376.3 million.

Here's why everyone freaked out
If you're wondering what threw Mr. Market into a tizzy, look no further than Lululemon's freshly lowered forward guidance.

Specifically, the company's now calling for fourth-quarter net revenue in the range of $535 million to $540 million based on flat comparable-store sales, and diluted earnings per share in the range of $0.78 to $0.80. As a result, Lululemon also expects full-year 2013 revenue to come in the range of $1.605 billion to $1.61 billion, with earnings in the range of $1.94 to $1.96.

By way of comparison, three months ago Lululemon told investors to expect 2013 revenue in the range of $1.625 billion to $1.635 billion, and full-year 2013 earnings of $1.94 to $1.97 per share.

When I look at the numbers side by side, Lululemon's downward revision admittedly seems insignificant. Remember, however, Lululemon stock certainly doesn't look cheap, trading for around 33 times last year's earnings and 25 times next year's estimates -- and at those levels, our fickle market doesn't take kindly to any negative news.

The silver lining
But even though I just purchased my first shares of Lululemon two months ago, I won't hesitate to admit I'm perfectly happy weathering yesterday's drop.

To explain, allow me to turn to Warren Buffett, who wrote in his 2011 letter to Berkshire Hathaway shareholders:

The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon.

In fact, Buffett even went so far as to compare those "net buyers" who take comfort when stock prices rise to "a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply."

Don't get me wrong. This advice certainly doesn't apply if something happens to significantly alter the investment thesis for any given company. But make no mistake, I remain a net buyer of Lululemon stock in the future.

Here's why I'm sticking around
Why? Because despite its near-term struggles, I'm still convinced Lululemon's long-term story remains firmly intact.

To be sure, the slowdown in fourth-quarter traffic remains a concern, but some of that can be attributed to broader difficulties in the retail industry in general. Then again, Lululemon CFO John Currie was quick to admit it would be "naive" to think the company's recall woes and recent PR setbacks haven't had at least some negative impact on the business.

What's more, Lululemon is currently absorbing the cost of revamping its entire sourcing process to improve on-time delivery and quality control, stricter standards that have temporarily resulted in uneven product flow and, in some cases, canceled purchase orders.

With this in mind, I couldn't have been more pleased when Currie elaborated,"We know that any lost sales incurred during the fourth quarter resulting from this increased focus on quality is a smart investment for the long-term health of the business."

If that's not a truly Foolish (with a capital "f") statement, I don't know what is.

As a result, and even though Lululemon's gross margin continued its decline in the third quarter -- this time by 150 basis points to 53.9% -- Currie once again insisted there was no reason to change his long-term outlook for gross and operating margin to ultimately return to their respective 55% and 25% ranges once Lululemon has managed to successfully streamline its supply chain.

In the end, that's also why I'm convinced that now-former CEO Christine Day was sincere when she assured investors back in June that, even without her leadership going forward, investors should rest easy knowing "plans have been laid for the next five years and a vision set for the next ten."

As a Fool who plans to continue buying shares of Lululemon over time for the duration of that vision, those words are music to my ears.

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