lululemon athletica (NASDAQ:LULU) has built an enviable consumer following, but the company has had its fair share of struggles over the past few years, including the mis-management of customer concerns over quality in 2013. That pitfall caused lululemon's share price to fall sharply during the past year, but investors may have reason to be optimistic heading into the holidays. Here's why.
First, a bit of background
As of the end of last quarter, lululemon operated 270 stores, as well as an online store, which predominately market women's exercise clothing with a focus on yoga, a stretching and meditative form of exercise that has gained popularity over the past five years.
A surge in yoga's popularity led to lululemon's sales jumping from $1 billion in 2012 to $1.4 billion in 2013, however, controversy surrounding the level of sheerness in the company's yoga pants in 2013 created headwinds that weighed down the company's growth. As a result, lululemon's sales increased by less in 2013 than they did in 2012, improving from $1.4 billion to $1.6 billion.
The deceleration in growth and executive turn-over tied to the handling of the product quality concerns led to shares slipping from a peak over $82 per share in the spring of 2013 to a low of $37 this past summer. What makes that decline even more frustrating to investors is that the S&P 500 has registerd double digit gains. That divergence is testing shareholders patience, however, lululemon's financials suggest that shares may be about to turn the corner.
By the numbers
Despite the downward dog debacle, consumers have remained mostly loyal to lululemon's brand and that has allowed the company to post ongoing sales growth, both in its stores and online.
Thanks to the addition of 16 locations in 2014 and a 27% year-to-date bump up in direct-to-consumer sales, lululemon's trailing 12 month sales have continued to expand, growing from less than $875 million in 2011 to $1.67 billion exiting the third quarter of 2014.
Sales momentum tied to new stores, quality and service initiatives, and investments in growth, including an expansion deeper into men's clothing, have solidified the company's top line, however, they've done so at a cost.
lululemon's profitability has fallen during the past year as the percentage of money spent on selling, general, and administrative expenses has inched up from 28.25% to 29.37%. That's contributed to the company's trailing 12 month operating margin sliding from 29% in 2012 to 23% last quarter.
As you'd expect, sliding operating margin is weighing down net income. Trailing 12 month net income has fallen from a peak of $275 million earlier this year to $243 million exiting the most recently reported quarter.
Investors need lululemon's top line growth to translate into a recovery in profit growth. But in the meantime investors can take solace in knowing that the company's balance sheet appears to be in good shape.
The company's current ratio, which measures a company's liquidity by taking a company's current assets (cash, cash equivalents, receivables, inventory) and dividing them by the company's short term liabilities (notes payable, current debt payments, payables, accrued expenses, and taxes) is attractive at 8.48 and suggests that lululemon has plenty of firepower to handle its financial obligations.
Importantly, the company's cash position is getting even stronger. lululemon remains debt-free and the amount of cash on its books has grown from $610 million a year ago to $725 million in August.
In addition to offering investors a solid balance sheet, the company's trailing 12 month price to net diluted earnings, or P/E, ratio in the high 20's is near its lowest on record. Similarly, lululemon's shares are trading near their lows on a price to sales basis as well. The amount that investors are paying for every dollar of revenue is just 4.23, which is significantly less than the nine times sales ratio they were paying in 2012.
Executing on growth
There's little question that lululemon has a lot of hurdles to overcome if it hopes to win back jaded investors. Management will need to demonstrate over the coming year that its investment in new stores and its expansion into new product lines will pay off with a re-acceleration in earnings. If the company can do this, then investors may find that the sell-off in lululemon's shares proves to be a good long-haul opportunity. However, since that's not a given, shares remain best suited to investors who are bit more risk tolerant. After all, lululemon has yet to demonstrate that margin and earnings growth will rebound.