Lululemon Is Set To Turn Around

| About: Lululemon Athletica (LULU)

In the past few days, Lululemon Athletica (NASDAQ:LULU) had gone through quite a slump after its 2013 Q1 earnings report. I know what people are saying about LULU at the moment. I will explain how to make sure if LULU will poise to pull back over time.

The earnings for Q1 aren't bad at all. In fact, LULU beats earnings and gives a positive guidance for the year. For the quarter ended May 5, LULU beats both revenues and earnings expectations. Revenue for 2013 Q1 was 345.8M dollars versus previous expectation 341.5M dollars. EPS for 2013 Q1 was $0.32 per share versus previous expectation $0.3 per share. For the quarter, gross margin was 49.4%, 560 basis points worse than prior-year quarter. Operating Margin was 19.1%, 650 basis points worse than prior-year quarter.

The company expects that next quarter's estimate for revenue will be around 340M-345M dollars versus previous expectation 328.9M dollars. As for the whole year EPS, the company suggests that 2013 EPS will be about $1.96-$2.01 per share versus previous expectation of $1.99 per share.

Although the fact the stock price dropped more than 18 dollars per share, the earnings and future projections still keep the fundamentals buoyant. However, the crowds think otherwise. Sterne Agee lowered LULU's rank to Natural from Buy. Target price is now lowered to $75 from previous $90. Our beloved Jim Cramer also ranked LULU a Sell. Cramer previously ranked LULU a Buy on May 30, 2013. Just a month after, he completely murdered his previous call as usual.

Things look very bad for LULU. The fact LULU's director and founder both sold shares before and after the 2013 Q1 earnings report may trigger even larger slump in the stock price.

If I am correct, this is probably the biggest consecutive drop in the stock price since 2011. (Back in 2011, there was a big market pullback for those of you who don't remember) I must say this is a bad time for LULU as many negative factors cross the road ahead. First, we have the transparent yoga pant recall issue, which caused the company lost more than 45M-50M dollars for the whole year. Second, the former CPO Sheree Waterson (Chief Production Officer) was resigned as a result of the sheerness issue.

Clearly we see the board has made internal replacements and resignations. When Waterson left LULU, specific reasons for the departure were not disclosed. This time, Christine Day commented her departure as a total "personal" decision. Indeed, we have seen how the market takes a personal response. It's not pretty. The board should have thought about this coming, and that's why Wilson sold shares before the earnings report. Well, there is no "expected" way to tell investors that the CEO is leaving at the end of the year.

Unlike Deckers (NASDAQ:DECK) and Green Mountain Coffee Roasters (NASDAQ:GMCR), LULU's problems don't show on the balance sheet. Numbers still look great, stock price becomes much cheaper. But how do we know that the company will keep growing after a big mess?

There are three questions that we should ask before investing in LULU.

  • How important is Christine Day?

I think Apple (NASDAQ:AAPL) set a bad example of the departure of a great CEO. Remember, AAPL is a technology company. LULU after all is a retail company that is very good at marketing and inventory control. People are happy to pay premium price for its products. Day may be a very good CEO creating such a brand aura for LULU but she's definitely not the only who can do it. A problem for AAPL is that Steve Jobs was the only one that everyone admired. Christine Day on the other hand, has no personal affection among the costumers. I bet 100 dollars that normal LULU costumers don't know about Christine Day. As long as the new CEO won't do anything stupid by my standard, I will keep my thumb up for LULU.

  • What is the right valuation for LULU?

LULU's balance sheet looks very robust. Cash and cash equivalents is recorded 588.418M dollars. There is no long-term debt. Gross margin is under pressure as cost of goods sold went up compare to last year. Operating margin is also under pressure as the company keeps expanding its market territories. The EPS for next year is now 2.57. Annual revenue growth rate sets at 20% level. I would say the fair valuation without brand premium is $50. Anything close to that price level is tempting to me.

  • Will yoga die?

Apparently the answer is NO. Yoga has grown exponentially as a healthy practice all around the globe. It's no doubt that LULU will face furious competitions. Nike NKE and The Gap GPS are also making yoga pants that attract potential customers who aren't willing to pay such a high premium for LULU. After all, the brand aura is the key. In long run, I can see that LULU will slow down as it reaches business boundaries. The company is trying to diversify its products and I am keen to see how it goes.

Day's departure won't be such a big deal after years. The Sheerness issue had a bad impact on the business but it is recoverable. LULU's key is to build its brand as it keeps refining its products and management. We can think of the hard time as a knife that cuts off the useless branches. LULU is poised to pullback over time.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LULU over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.