Fourth Quarter Retail Guidance Remains Rough

With the end of the retail earnings season, we can take a quick look back at the mixed third quarter. Heading into the holiday season a number of retailers on both the high and low ends struggled to give the Street what it was looking for in terms of guidance. High expectations were largely seen across the board--after all, you really cant have low expectations for earnings when the broad market sits 25% higher this year.

At the start of the season, we had a number of lower-end names like Wal-Mart and Target that warned of a tough environment and economic landscape report earnings. At this point, a number of analysts (including myself) pointed to the higher-end for stronger returns. While a tough employment situation coupled with stagnant wage growth may hurt lower tier spending, the upper income brackets benefited greatly from rising asset prices within the equities and real estate markets. However, over the last couple weeks a few high flying names have been shot down on the back of weak fourth quarter guidance and mixed news. 

Guidance looks sheer
Following a decent third quarter report, shares of LululemonAthletica  tumbled by over 10%. Lululemon's revenue of $379.9 million was up 20% from $316.5 million in the comparable year-ago quarter. Comparable store sales improved by 5% on the back of a promotional environment, but consequently gross margins felt pressure. All eyes were focused on fourth quarter guidance to justify the company's lofty valuations.

The company lowered its sales forecast to range between $535 million and $540 million. Lululemon expects that weak sales trends witnessed so far will continue throughout the holiday season. This forecast is substantially below the company's previous sales expectation of $565-$570 million. On the top line the company now expects revenues in the fiscal year to come in the range of $1,605.0 to $1,610.0 million, down from $1,625 to $1,635 million forecasted earlier in the year.

Yoga pants are getting competitive
Increasing competition with the space has caused concern for investors in athletic apparel. Companies like The Gap  have made waves with very similar offerings and high product quality. Through Athleta, Gap has been actively taking market share within the yoga apparel business. Gap acquired Athleta in 2008 for only $150 million, and since t has actively expanded and integrated its brand into the entire company. 

In the most recent third quarter conference call, executives from the company seemed exceptionally positive when discussing Athleta's future. Moreover, the lower price point of Athleta may tend to pull customers away from the higher priced Lululemon offerings. Going forward, continued roll out of Athleta brick and mortar locations should be beneficial on both the top and bottom lines. Year to date, shares of Gap have done especially well, with returns of 23%.

Unfortunately for shareholders, Lululemon continued its decline in the days following the earnings announcement. Shares of the company now trade at a discount of more than 35% to the pants, which tend to sell for $90 a pop. 

Ultra hurt
Ulta Salon , Cosmetics & Fragrance  has been a huge winner since its initial public offer back in 2007 as the brand expanded drastically. For the last few years, Ulta has been a trader friendly stock, trading with volatility and hype. However, earlier in the month shares plummeted on weak guidance. 

Ulta announced that it expects fourth-quarter earnings to come in between $1.07 to $1.10 a share, compared to consensus estimates of $1.24 a share. Net sales during the fourth quarter are expected between $853 million and $867 million. On a year over year comparison, sales in last year's fourth quarter totaled $758.8 million, including $40 million of sales in the 53rd week of the year, the company said. On the top line analysts, on average, had expected sales of $895 million for the January-ending quarter.

A still fragile consumer is having difficulty spending on discretionary goods--perhaps expensive cosmetics are out of the middle income's medicine cabinet at least the next couple months. 

When the fourth quarter reports begin rolling around it will be interesting see if retail comes in strong. Lower guidance from the higher end during the third quarter gives investors a cautious signal that the economy is still in recovery. Increasing competition within the yoga apparel space may certainly pressure Lululemon. Along the same lines, investors should remain hesitant to invest large portions of their portfolio in company's with lofty valuations like Ulta.

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Nathaniel Matherson has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica and Ulta Salon, Cosmetics & Fragrance. The Motley Fool owns shares of Ulta Salon, Cosmetics & Fragrance. 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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