Reassessing the Growth Potential at Lululemon
We're only 16 days into 2013, and already lululemon athletica is having a roller-coaster year. Unfortunately for investors, the coaster has only done that first bit so far, where your stomach jumps up into your throat and you start to wonder about structural stability -- it's also called "the going down bit." After close on Monday, the yoga retailer announced that revenue was going to come in at the high end of its projection, but that still falls short of what the market had been hoping for. As a result, the company's stock had fallen 10% in early trading, though it started to make up ground in the middle of the day.
Just last week I wrote an article saying that Lululemon was still a good -- through pricey -- investment. Here's a fresh take on the company, its growth prospects, and what 2013 holds for it.
The new information
For the past few years, Lululemon has updated its fourth-quarter guidance before heading to ICR XChange. This year, the update sounded good. The company said that revenue was going to come in at the upper end of its predicted $475 million to $480 million range. It also upped its earnings-per-share expectations to $0.74, which is $0.01 above the top of its previous prediction. Lululemon also said that its gross margin was going to come in ahead of its plan, and that inventory was in a good place. What's not to love?
Thank God for analysts, or we would have all been excited about this. While the revenue forecast increased, analysts were looking for a bigger jump up to $489 million. That "shortfall" is the main thing dragging Lululemon down today.
Danger lurking at every turn?
Now if it seems like that last section was a bit snarky, I apologize. I've liked Lululemon for a long time, and these sorts of setbacks always seem superficial. But that's not a fair analysis of what's going on here, and we should look deeper to see if there are real red flags being raised. Lululemon's stock has thrived on high sales growth, high margins, and the possibility of expansion. This result is certainly a ding to its reputation as a fast grower. In the prior year's fourth quarter, revenue increased 51%. If it hits the very top of its forecast for the most recent quarter, $480 million, it will only have grown revenue 29%. That's a big pullback from last year, and it doesn't go very far toward justifying the company's P/E, which is hanging out above 40.
The other two portions of the company's appeal are less worrisome. With gross margins ahead of plan, Lululemon is showing that increased competition from brands like Gap's Athleta and VF's Lucy haven't hurt pricing power. The margin game has been Lululemon's bread and butter, and there were concerns that lower-priced brands -- Athleta runs about 20% cheaper -- would put real pressure on the company. So far that hasn't happened.
The real red flags
So what is going wrong? Lululemon still has a strong brand, great pricing power, and excellent expansion potential. What's wrong is that last word: "potential." Lululemon has been working on expanding its offerings and store footprint for a while, but that side of growth has been slow. Toes have been dipped into men's clothing, running gear, swimwear, and international expansion, but the company has yet to take the plunge, and that poses two big problems.
First, it could get beaten to the punch. VF is in talks to buy out Billabong, which would give it some international exposure, and would give it a meaningful swim line that could be integrated into its Lucy line. Likewise, Gap already has a swim line, and it's been pushing hard on the Athleta brand. It's only a decision away from making a big international move.
Second, Lululemon needs the expansion to continue growing in its current stores. As a Credit Suisse analyst pointed out last week, and reiterated today, the company is near its saturation point for older stores. With a limited line, there are only so many yoga enthusiasts that can walk through the doors every day. That's a real concern for the company as it starts to slow its domestic store growth.
The bottom line
Lululemon needs to move more quickly to expand its line and international store footprint, in order to keep up with investor expectations. I'm very bullish on the branding, the product, and the company's management, but I'm genuinely worried that it won't act fast enough. That worry scares me off the current stock pricing. While it might mean missing the best boat, I'm waiting to see how the first quarter falls out before I make a decision to buy.
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The article Reassessing the Growth Potential at Lululemon originally appeared on Fool.com.Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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