There is no denying the fact that lululemon athletica (NASDAQ:LULU) continues to disappoint, even frustrate, investors as shares continue sinking to fresh 52-week lows. But investors who have already thrown in the towel and deemed Lululemon's future weak and unattractive are wrong.
While investors could reasonably assume board turmoil and management scuffles will persist and put downward pressure on shares in the short term, the current share price does not reflect the long-term brand value or earnings potential.
Fixing inventory issues
Despite a sub-optimal product assortment, Lululemon still generated an attractive 18.1% operating margin in the first quarter. Lululemon's operating margin is even more attractive when the company is operating in an increasingly competitive environment.
Lululemon isn't sitting back and allowing competitors to swoop in and take market share. However, there are legitimate concerns that Lululemon is losing its "premium" reputation. Lululemon is preparing to implement a new process and systems solutions in 2015 to improve stores' seasonal and core product mix.
During the first quarter, inventory grew 23.4% to $177.4 million, outpacing sales growth by a sizable amount for the second straight quarter. The inventory build relates to a higher composition of core inventory, which the company expects will be rebalanced and adjusted for year-end 2014.
Lululemon's CEO Laurent Potdevin commented during the company's first-quarter conference call that the new process will only see a measurable impact in the second quarter of 2015. Make no mistake about it: Lululemon is taking the right steps today to fix its troubled inventory issues for the long term.
Lululemon's outgoing CFO John Currie explained to analysts during the first- quarter conference call that the company is opening up "pop up stores" that are able to clear excess inventory at full price. Speaking of Currie, the 60-year old executive will retire at the end of the fiscal year to fulfill several personal objectives, including spending more time skiing.
Currie's retirement set for the end of the fiscal year provides plenty of time for the company to search for a replacement and ensure a smooth transition. While management transitions at a turnaround period are not ideal for investors, Currie's comments should erase any doubt that Currie is retiring for any other reason or that he is being forced out of the company.
2017 isn't that far away
Lululemon's international expansion could be seen as its largest catalyst for growth. Throughout 2014 and 2015, Lululemon is focusing on growing its showroom network with store rollouts that will only ramp up in 2016. A year later, the company expects to have a presence of more than 20 stores in both Europe and Asia.
Currently, Lululemon has 24 stores in Australia and New Zealand, nine in Europe, and seven in Asia. With a focused and unique approach, Lululemon's international stores are designed to build customer awareness and recognition before a store even opens, as explained by Potdevin:
So as we think about our international expansion, we're staying very true to our showroom strategy, which is to build awareness in the market and build momentum...and we expect the showroom to have a lifespan of 12-to-18 months before we're ready for store rollout. So we're going to be in the next 18-to-24 months, we're going to really accelerate the showrooms internationally, and then that's going to trigger [the] store rollout 12-to-18 months following that.
Lululemon has guided toward a long-term operating margin returning to the mid-20s as the company successfully expands into new markets internationally.
Make no mistake: the competition is real
Lululemon could face further downside if the competition becomes more intense. Many Lululemon customers demonstrate extreme brand loyalty, and it is unlikely that its competitors such as Under Armour (NYSE:UAA) would be able to convert these customers. However, as Lululemon's recovery isn't expected to occur until 2015, the company may face issues attracting new customers.
Lululemon will be fighting against Under Armour's already existing $500 million sales in the women's category, which the company expects to double to $1 billion by 2016.
In order to achieve its growth prospects, Under Armour has successfully set up floor space at retailers such as Dick's Sporting Goods and Macy's. Lululemon selling its products at retailers would likely dilute the brand image, leading to further declines until its anticipated recovery in 2015.
In the meantime, Under Armour will gladly continue operating via the wholesale route (in addition to operating its own flagship stores, such as its 20,000 square foot Brand House in Soho, New York) and taking a page out of Lululemon's playbook by hosting brand awareness and demonstration events.
Investors may already be factoring in Under Armour's growth story, as shares are trading at a hefty P/E just north of 77. On the other hand, it's possible investors are not giving Lululemon's turnaround and growth prospects enough credit, as shares are trading at a P/E of barely 20, which is also lower than industry leader Nike's P/E of 25. Lululemon investors should remain hopeful but cautious and expect a bumpy road ahead with a promising future.