3 Ways Lululemon Can Stay Out of Trouble

How can Lululemon recover from the controversies while staying ahead of Gap and L Brands?

Brandy Betz
Brandy Betz
Apr 9, 2014 at 10:00AM
Consumer Goods

Athletic apparel company Lululemon (NASDAQ:LULU) has started spring on a high note. The fourth-quarter report and conference call caused the company's shares to close up 6% that day. Also, the company has now prevailed in lawsuits which stemmed from last year's yoga pant recall fiasco. Lululemon's controversial founder has stepped into the background and a new CEO has taken the reins. Will the good times last and keep Lululemon ahead of competitors that include Gap (NYSE:GPS) and L Brands (NYSE:LB)

Lululemon's fourth quarter included net revenue of $521 million -- up over 7% year-over-year -- which bested the $515 million consensus estimate. The company also topped the consensus earnings per share estimate of $0.72 with a reported $0.75. This marks the fifth quarter in a row that Lululemon has beaten the revenue and EPS estimates.

However, the company still has to overcome the tidal wave of bad press from last year. Here are three ways in which Lululemon will try to redeem its reputation in 2014. 

Source: Lululemon

1. Decreasing scarcity while improving quality  
Lululemon has focused on a limited stock inventory model that is meant to drive demand. However, the yoga pant recall last year showed the weakness in this model. Sheer material led to the recall of about 17% of the popular Luon pants. Replacement pants took longer than expected to hit the market, which left shoppers without the matching bottoms to tops that were in stock. 

On the fourth-quarter conference call, new CEO Laurent Potdevin said, "While we don't mind our guests being hungry for our product, we don't want them to starve for it."

Keeping guests from "starving" will come down to finding a balance between the core and seasonal styles -- the latter of which has come to dominate Lululemon's overall sales. It's a balance that the company needs not only to satisfy customers in the short-term, but also to create some wiggle room if another product recall were to happen in the future. 

Lululemon has also paid lip service to improving quality control so that a Luon pant incident doesn't happen again. However, the company will have to prove that it has this ability with time. For a brand renowned for quality, the recall issue raised serious questions about whether the production process had changed. That's a nervousness that will only quell if the company avoids similar problems this year. 

2. Vital expansion overseas  
At the end of the fourth quarter Lululemon had 254 total stores, with 199 belonging to the base used for comparable-store sales comparisons. Of those base stores, 65% are located in the United States. In comparison, Gap has 3,100 total stores and L Brands-owern of Victoria's Secret and Bath and Body Works- has nearly 3,000 stores. So Lululemon has a much smaller footprint overall.

Lululemon's comparable store sales has trended downwards in recent years. 



























Source: Company filings 
What's driving these comps down so much? The definition of comps means that the stores have to exist for at least a year. Comps losses can happen for several reasons. Lululemon's limited product offerings mean that customers don't need to shop as often since few people need a closet full of yoga apparel. Gap and L Brands have the advantage there in that the companies offer more everyday apparel. 
Comps drops can also suggest either too many stores in the same area, which can cause cannibalization between locations, or the fact that there's not enough new stores to keep the growth momentum. Lululemon's overall store number suggests its not the former reason.  
But though there's still room for growth domestically, Lululemon has its sights on broadening its overseas presence. The current comps fleet only includes 23 stores in Australia, plus the company recently opened a store in New Zealand. 
During the fourth-quarter conference call, Laurent Potdevin said that the company has employees in Asia and Europe scouting potential locations. Lululemon is open to collaborating with partners to open locations in trickier markets such as the Middle East.
Overseas expansion is the metric that will measure Potdevin's performance. A recently opened London store hopes to show investors that Lululemon can prove successful abroad and a second store will open in that city later this year.
3. Keep Chip Wilson in the background  
Lululemon's controversial founder Chip Wilson announced that he was stepping down from his board position at the same time when the company revealed Potdevin as the new CEO. Wilson inspired backlash last year when he blamed the pant-quality issues on customers' bodies. He responded to the backlash by apologizing -- to members of his company, rather than insulted customers.
That was merely the latest of a long string of foot-in-mouth comments from Wilson. His behavior is also rumored to be the reason why former CEO Christine Day announced her plans to step down last summer. True, some investors -- and customers -- had called for Day's head due to the quality issues. However, she had played a major role in growing Lululemon's brand.
If Lululemon's controversies continue into 2014, customers may well turn to the company's increasing number of competitors.  Gap had a total of 61 domestic Athleta stores at the end of the fourth quarter and that athletic-apparel spin-off has lower price points than Lululemon.  L Brands' Pink stores also offer cheaper yoga apparel with a more trendy styling that would appeal to younger, cash-strapped yoga devotees. 
Foolish final thoughts 
Lululemon needs to move past the controversies of last year with a better supply chain, no quality issues, and a muzzle for Chip Wilson. However, expansion abroad will serve as the major test for the company-and its new CEO.