Is Lululemon more than a passing fancy?

This once-trendy name is facing headwinds, and it will struggle as it continues to mature.

By StreetAuthority Nov 21, 2013 3:50PM
Caption: A customer enters the Lululemon store in downtown Vancouver, British Columbia November 8, 2013By David Sterman                                                                         
Years ago, as I was strolling on a beachside boardwalk, I looked around and realized I was the only person in my area not wearing Crocs (CROX), the somewhat ugly plastic shoes that had become all the rage. Clearly, these folks were not alone: Sales of Crocs soared from $14 million in 2004 to $355 million in 2006.

Even though sales would rise another 139% in 2007 (to $847 million), investors who bought in while growth remained above 100% learned a terrible lesson. All fashion fads end -- sometimes very badly.

Yet every few years, investors repeat this classic mistake, assuming strong growth can continue for a very long period. Even the best retail brands eventually cool off. Sales at Nike (NKE) for example, have risen just 7% annually since 2005, despite a compelling international expansion strategy and a broadening line of products.

The reason for Nike's recent phase of slower growth: The company's brand is no longer a fad, and management has had to work hard to play up the performance attributes of its products. It was a logical response for that phase of the company's growth cycle. That's also a strategy deployed by Under Armour (UA), a richly valued retailer that is transitioning from fad status into a value/performance proposition for its athletic apparel.

Of course, Crocs never had such an ability to talk about performance, which was its eventual undoing. And the same factor could lead to a share price tumble for Lululemon (LULU), which is only beginning to feel the effects of a series of missteps.

Much has been written about this yoga apparel purveyor, which I will only briefly summarize here:
  • The company's products had a major manufacturing defect, which led to a huge and costly recall.
  • The company's former CEO has been trying to leave and is only sticking around because a new successor hasn't been found.
  • Efforts to get fresh inventory on the shelves is likely to lead earnings per share (EPS) results in the October quarter to be flattish, in contrast to many quarters of solid year-over-year profit comparisons in the past.
  • Though shares have pulled back a bit recently, they are still up nearly 400% from four years ago. 

Investors are clearly assuming that Lululemon can get past these headwinds and resume its impressive growth trajectory. Indeed, consensus forecasts currently call for a 21% spike in fiscal 2015 sales (to just shy of $2 billion) and a 25% spike in EPS (to around $2.50).

But as was the case with Crocs in 2007, investors may be missing warning signs that Lululemon's robust growth prospects will soon be a thing of the past.

Sam Poser, who follows the stock for Sterne Agee, thinks that the recent woes are symptomatic of a larger problem: "The care afforded to product quality, innovation and customer care, which allowed for sales per square foot of $2,000 and 25% EBIT margins, has already dissipated." He sees operating and net margins falling 2 to 3 percentage points in the years ahead, compared with the fiscal 2013 peak.

And that in turn sets the stage for decelerating EPS growth from 60% in fiscal 2012 to and 46% in fiscal 2013 to around 16% by fiscal 2016. Meanwhile, shares trade for around 26 times his fiscal 2016 EPS forecast of $2.70, which explains Poser's "underperform" rating and $56 price target.

But Poser doesn't even touch on a rapidly intensifying competitive environment. In recent months, Gap (GPS), Under Armour and Nike all have either unveiled or announced plans to unveil yoga apparel. You don't have to question whether the yoga apparel market is still growing or plateauing, but you can question whether Lululemon can still count on strong market share when these three great retailers all aim their sights at the company.

If you know anyone who is an active yoga participant, ask them how the Lululemon brand is now perceived. And also ask them if apparel from other brands is starting to show up. That would be a sign that competition is starting to take root.

Risks to Consider: As an upside risk, Nike, the Gap, Under Armour or another retailer may look to acquire the company to gain a faster foothold into the yoga apparel market.

Action to Take: Lululemon will report fiscal third-quarter results and provide fourth-quarter guidance on Dec. 13. Right now, consensus forecasts call for a 19% spike in third-quarter sales, to $376 million, but the company has already told analysts that the inventory mess wasn't fixed until the quarter was well underway. That means that there is a much greater chance of a shortfall than upside, relative to forecasts, and a key reason why you shouldn't try to bottom-fish this stock after it has fallen more than 10% since late September.

Long term, there are reasons to suspect that Lululemon will struggle as it enters the maturity phase of its growth cycle. Rising competition and less attentive management are early warnings signs for a once-hot retail name that appears to have peaked.

More from StreetAuthority

Nov 22, 2013 11:59AM

Yeah, I like the girl also --- much more than the apparel.


BTW, I think that this company is on its way out, just the same as all fads, including Facebook, Twitter, Linkedin, etc.  Fads all have a short half-life and eventually give up the ghost when people get tired of them, and all of these are fads.  People eventually get tired of wasting time and money on them and look for the next useless fad.  My advice, if you have any money in them, grab it and run ASAP for the nearest exit.

Nov 22, 2013 2:05PM
I have never heard of LULULemon so no way I would ever buy it -  People love this fad stuff - but it doesn't last , they move on to the next cool thing.
Nov 23, 2013 1:50PM
Everytime I hear the name Lululemon, I think of Ayn Rand and other sheer fantasies (pun intended).
Remember Lulu's John Galt bags?

Maybe Lulu and Abercombie and Fitch should merge to create the ultimate Conservative's Apparel Brand....both are overpriced and exclusive, and have wingnut CEOs
Nov 22, 2013 10:40AM

Personally Dave, I think that is a nice looking pair of black spike heels...Oh yeah, not a bad butt either.

Think my B-i-Law did fine on CROX at one time, I just made about 10-12%...

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