After a volatile spring during which saw Lululemon (LULU) reduce its earnings forecast for 2013 by more than 15% on its now infamous pants recalls, the latest data from our proprietary channel checks indicates that demand may have dramatically improved.
Revisiting last quarter's messy results and outlook, most analysts believe that Lululemon likely saw both deteriorating reviews from customers and slowing sales which put prior Q1 estimates in jeopardy. Some analysts believe they used the opportunity to blame faulty/sheer yoga pants. However, the fact that these pants have been in production since late December (from reviews seen here), its timing of waiting until March clearly indicates that the company was hoping "Lulu addicts" would not notice the thinner pants and thus poorer quality.
Finally, LULU decided to throw its Taiwanese supplier of pants under the bus and later fired its Chief Product Officer (full release here). Lululemon management used clever phrasing in order to spin the problem as a one-off as the recall stated "We have determined that certain shipments of product received from our factories and available in store from March 1, 2013 do not meet our technical specifications."
Interestingly, the supplier defended itself in a well publicized fashion magazine highlighted by the WSJ's write up here. The manufacturer Eclat's CFO Roger Lo told the WSJ that "All the pants were manufactured according to the requirements set out in the contract with Lululemon."
In the aftermath of the "recall", management used the opportunity to lower the bar for the entire 2013 outlook, dropping its eps target to a midpoint of $1.97 as well as implying a lower growth rate than the previous expectation close to 25%. To date, most LULU analysts have shown a very poor ability to forecast underlying trends. At the low point for 2013, with the stock near $64 on the heels of the poor outlook, a slew of them downgraded the stock and lowered their targets. Several LULU analysts that investors may wish to be wary of include: Janney Capital analyst Adrienne Tennant and Betty Chan at Wedbush, both of whom bottom ticked shares. Also providing poor forecasts were Goldman Sachs and Macquarie both of which initiated with the dreaded neutral rating and price targets which are now well under water.
With more realistic growth goals, several factors are no longer headwinds for LULU and could result in better than expected Q2 results, but more importantly the FY 2013 overall outlook. Improved weather in the Northeast, Midwest and Canada, a region where more than 60 stores operate, should add significantly to comparable same store sales performance in the 2nd quarter.
Additionally, our checks indicate a much wider assortment of spring and summer gear compared with a year ago, which focused primarily on swimming during the summer months. Despite fewer types of the previously popular yoga pants such as the Astro pant available, other brightly colored pants have shown very strong demand. Proprietary store checks of more than 24 stores indicate that the brand is still well received, and despite prices nearly double that of competitor products, affluent women in the 30-45 demographic continue to gladly overpay for the brand's allure.
Time will tell if consumers will continue to pay a premium price for an apparel item that is available in near identical quality at 60-80% below its $95 price tag at stores like Target, Costco and others. So far, well-funded, established competitors such as Gap's Athletica and Lucy have been unable to knock off Lululemon from its perch at the top of the yoga pants fad.
Over the past few weeks, along with almost every other consumer stock, LULU shares have vaulted higher and are now up on the year, despite reducing growth. For Q1, analysts are looking for $341mm in sales, which is near the higher end of management's recently provided guidance for $333-$343 million. In terms of comps, expectations are for mid single digit comp growth. However, if management does not provide a detailed time frame for restocking the popular pants, operating results could be of lessor importance. So far, LULU management has been able to sell its story well to the street, and its share price has been rewarded as one of the most expensive in the entire apparel universe but another slip-up could derail shares.