Lululemon Faces Tough Task Getting Back on Its Feet

Lululemon Faces Tough Task Getting Back on Its Feet

As fashion trends go, “athleisure” is all the rage these days. Slacks and high heels have given way to leggings, track suits and sneakers, sometimes even in the boardroom. Athleisure is even being added to the Merriam-Webster Dictionary

And yet a stock chart of one of the market’s pioneers, Lululemon Athletica Inc, doesn’t reflect such enthusiasm. Product recalls, public-relationsnightmares and a management shake-up in recent years have hit Lululemon hard. While the company has aimed to retool its image, it now finds itself in a crowded marketplace and tough macroeconomic environment.

As Lululemon gets set to report fiscal third-quarter results on Wednesday, a return to the glory days does not seem in the cards.

Analysts polled by FactSet predict Lululemon will report earnings of 37 cents a share, down from 42 cents a year ago. Odds are it will beat estimates. Lululemon has exceeded the consensus target all but twice over the past 11 quarters.

However, headline numbers tell only part of the story. Lululemon has recently been hampered by bloated inventory and falling margins. There is little reason to believe those trends have changed materially.

A glut of inventory has already hurt a number of retailers ranging from specialty to department-store chains. In a recent report, Macquarie Research identified Lululemon as one of 10 retailers whose inventories were growing faster than normal ahead of the holiday season.

What is more, Lululemon’s gross margin has fallen in seven of the past eight quarters and most recently reached its lowest level since 2009. It may need to cut apparel prices faster than it would like in order to clear unsold merchandise, piling additional pressure on margins.

Granted, shares are cheaper than usual. The stock, which has lost more than a fifth of its value since September, trades at 23 times projected earnings over the next 12 months. That is nearly 30% cheaper than its five-year average.

The discount may not be worth the risk. Lululemon historically is volatile following earnings. The stock has averaged an 11% move in either direction following the past 10 quarterly reports.

While athleisure is everywhere, this downward facing dog is worth avoiding.

For the third quarter ended November 1, 2015:

  • Net revenue for the quarter increased 14% to $479.7 million from $419.4 million in the third quarter of fiscal 2014.
  • Total comparable sales, which includes comparable store sales and direct to consumer, increased by 9% for the third quarter on a constant dollar basis.
  • Comparable store sales for the third quarter increased by 6% on a constant dollar basis and direct to consumer revenue increased 21% on a constant dollar basis.
  • Direct to consumer net revenue increased 16% to $89.3 million, or 18.6% of total Company revenue, in the third quarter of fiscal 2015, an increase from 18.4% of total Company revenues in the third quarter of fiscal 2014.
  • Gross profit for the quarter increased by 7% to $224.8 million, and as a percentage of net revenue gross profit was 46.9% for the quarter compared to 50.3% in the third quarter of fiscal 2014.
  • Income from operations for the quarter decreased by 16% to $68.2 million, and as a percentage of net revenue was 14.2% compared to 19.4% of net revenue in the third quarter of fiscal 2014.
  • The income tax expense for the third quarter of fiscal 2015 was $12.1 million, which includes an income tax recovery of $7.7 million related to the Company’s transfer pricing arrangements and taxes associated with the repatriation of foreign earnings. In addition, there was a related net interest expense of $3.6 million. The tax rate excluding these adjustments was 28.8% in the third quarter of fiscal 2015 compared to 27.1% in the third quarter of fiscal 2014. The effective tax rate in the third quarter of fiscal 2015 including these tax and related interest adjustments was 18.6%.
  • Diluted earnings per share for the third quarter of fiscal 2015 were $0.38 compared to $0.42 in the third quarter of fiscal 2014. Excluding the above tax and related interest adjustments, diluted earnings per share were $0.35 for the third quarter of fiscal 2015.
  • During the third quarter of fiscal 2015, the Company repurchased 1.6 million shares of the Company’s common stock at an average cost of $55.50 per share.

The Company ended the third quarter of fiscal 2015 with $403.4 million in cash and cash equivalents compared to $633.6 million at the end of the third quarter of fiscal 2014. Inventory at the end of the third quarter of fiscal 2015 totaled $357.8 million compared to $229.9 million at the end of the third quarter of fiscal 2014. The Company ended the quarter with 354 stores.

Laurent Potdevin, lululemon’s CEO, stated: “We had a solid quarter in line with our expectations underscored by the combination of our product, guest and community initiatives along with tremendous guest reception to major store openings around the world. I would like to personally thank all of our educators who create amazing experiences for our guests every day.”

Potdevin continued: “We’ve implemented critical organizational changes this quarter and now have in place a complete, world-class management team that is aligned with our strategic global priorities focused on design and dedicated to creating long-term value.”

For the fourth quarter of fiscal 2015, we expect net revenue to be in the range of $670 million to $685 million based on total comparable sales in the mid-single digits on a constant dollar basis. Diluted earnings per share are expected to be in the range of $0.75 to $0.78 for the quarter. This guidance assumes 139.0 million diluted weighted-average shares outstanding and a 29.5% tax rate. The guidance does not reflect potential future repurchases of the Company’s shares.

For the full fiscal 2015, we now expect net revenue to be in the range of $2.025 billion to $2.040 billion based on total comparable sales in the high single digits on a constant dollar basis. Diluted earnings per share are expected to be in the range of $1.81 to $1.84 for the full year, or $1.78 to $1.81 normalized for the tax and related interest adjustments made during the third quarter of fiscal 2015. This guidance assumes 140.9 million diluted weighted-average shares outstanding and a 27.6% tax rate, which includes the above tax adjustments. The guidance does not reflect potential future repurchases of the Company’s shares.

www.lululemon.com


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