Lululemon Lived Up To Its Name In Q3. What Does The Future Hold?

| About: Lululemon Athletica (LULU)

Lululemon Athletica Inc. (NASDAQ:LULU) is a designer, manufacturer, and distributor of athletic apparel for women, men, and female youth (don't say teens or girls). It operates in the U.S., Canada, Australia, and New Zealand, and it is expanding into new international markets. Its offerings are generally chic. Its models are attractive, but seem to be chosen to be a bit less than perfect. In other words they are chosen so that buyers can identify easily with them. This is astute advertising. With relatively few stores, Lululemon has room to grow. However, LULU's recent social and business gaffe's have seriously stunted this expected growth.

Further Lululemon depends on being a "hot" commodity. It may be in the processing of ceasing to be such a hot commodity. This happens to a huge number of apparel manufacturers. What brings buyers in is the "chicness" or style of the clothes. However, as anyone who follows the garment trade can tell you, styles change. In fact, they are changed deliberately, so people have to buy the next "new style". This allows garment manufacturers to sell more goods. LULU now appears to be on the downhill side of this garment hill.

LULU's fiscal results for Q3 2013 were okay. Net revenue for Q3 2013 increased 20% to $379.9 million from $316.5 million in the year ago quarter. Comparable store sales increased 5% on a constant dollar basis. Direct to consumer revenue increased 37% to $62.0 million (or +16.3% of LULU's total revenues). The +16.3% of total revenue was an increase year over year from +14.3% of total revenue in Q3 2012. Gross profit for Q3 increased 17% to $204.6 million. One negative saw gross profit as a percentage of net revenue decrease to 53.9% from 55.4% year over year (a decrease in profit margins). Diluted earnings per share were $0.45 per diluted share on net income of $66.1 million. This was up year over year from $0.39 per diluted share in Q3 2012. Only the decrease in gross margins sounds bad, yet LULU's stock has plunged -15%+ in just the last week.

It wasn't really the Q3 results that did in LULU, it was the guidance for Q4 2013. LULU guided for "flat" comparable store sales in its biggest quarter of the year. This is extremely weak for a company that has produced EPS growth at an average clip of 54.00% per year over year for the last five years. Everyone knew growth was going to slow; but no one expected it to come to a complete halt. For many this is an omen that the momentum of LULU has been broken irrevocably. It probably means that LULU is falling out of favor. That is why investors are selling.

In my mind the eventual falling from favor of LULU was inevitable. Now that it has happened, I don't expect LULU to make a demonstrable comeback. It is a fad stock. It would have had trouble sustaining that "fad" attraction, especially with its high prices. On top of that it was getting increasing competition from competitors with more universal appeal (and bigger marketing teams and budgets). The competitors appeal to areas beyond the "yoga" fan base. Nike (NYSE:NKE), Adidas (OTCQX:ADDYY), Under Armour (NYSE:UA), and The Gap's (NYSE:GPS) Athleta brand are already becoming serious competition; and I am sure I have left out any number of others. This "tough" competition had to take its toll on sales and profits given time.

LULU speeded the above process along. Below is a list of some of its gaffes:

  • LULU, with a reputation for high quality, manufactured its most popular yoga luon pant to be see through (or nearly see through). The brouhaha about this has raged since March 2013. This by itself was a bad gaffe; but LULU compounded its gaffe by initially insisting that customers "demonstrate the see thoroughness" of the pant to store personnel, before the store would give the customer a refund. It later backed down on this demand. This demand was viewed as lewd and/or degrading by most customers. Some were appalled. Not only did LULU's reputation for excellence suffer, but its reputation as a "woman friendly" store took a huge hit. In addition there had to be a lot of married women who felt they could no longer afford to wear the luon pants; or they might be thought unseemly or lewd. LULU recalled 17% of its black luon pants for being too sheer.
  • Soon after this on June 10, 2013 LULU CEO Christine Day resigned. Some called this a "firing" after the big pant recall. It was a blow in another way too. Women liked the fact that "their" company was being run by a woman. LULU erred again by not hiring another woman to replace her. Being male, I like to see men get a fair chance; but this was one case where the hiring process virtually screamed for a woman. Hiring a man to replace a woman in a "woman's" store that was under attack for "lewdness" was sure not to sit well with many of LULU's customers. In addition, upon Christine Day's "firing" (or resignation), the company had no immediate successor in mind. The hiring of Laurent Potdevin on December 10, 2013 occurred only after a long search. This made the company look weak and unappealing.
  • In July 2013 employees accused the company of shunning plus-sized shoppers. The largest sizes (10s and 12s) were supposedly relegated to a separate area of a store; and they were left clumped and unfolded under a table. Further some newer styles were not even available in the plus sizes. Since almost every woman I have ever met is sensitive about her weight to some degree (even if they are thin), this had to alienate many women.
  • In October 2013 quality complaints resurfaced. Customers complained about sheerness and pilling yoga pants again. Regardless of LULU's actions, the likelihood of this happening seemed a foregone conclusion. Once a snowball starts rolling downhill, it doesn't usually stop. Unfortunately LULU's founder and Chairman Chip Wilson went on Bloomberg TV in November 2013, and he blamed "women's bodies" for the problem, specifically their "fat thighs". What he said may have been strictly true. However, women who are being lured into paying exorbitant prices for yoga pants don't want to hear that their "bodies are the problem". They don't want to hear that they have "fat thighs", even if they don't have "fat thighs". Such statements make almost any woman wonder whether she wants to wear that company's pants. After Wilson's comments, if a woman has any problems with the fit, it is her body which is the problem. How many women would want to put themselves at that risk? Wilson eventually apologized, but the damage had been done. Further many considered his apology insincere. He eventually resigned from his position as Chairman In December 2013.
  • Finally LULU had supply problems in the fall of 2013. These impacted sales; and the lack of new fall products probably also encouraged potential customers to find other brands to buy. Such customers will be expensive to lure back, if they come back at all.

LULU was probably a sports fad to begin with. Such fads come along all of the time. Many may remember how "hot" L.A. Gear was years ago. It eventually filed for Chapter 11 bankruptcy in 1998. L.A. Gear made a mild comeback later; but my point is that the stock as an investment was finished. LULU, if not at that point, is quickly approaching that state. LULU has alienated too many women. In many ways it was inevitable that this would happen. There have been many of the same complaints about sheerness with The Gap's Athleta brand pants too; and they sell at about two thirds the price of LULU's (or even less at sale prices).

Conversely NIKE has been one of the few sportswear stores to remain at the top over the long term. It has done this by continually signing the top athletes around the world to advertisement contracts. Is there even a top yoga athlete? To me it seems as if LULU was preordained to follow the long list of flash in the pan "hot" sportswear and apparel makers.

Does LULU make a good product? Many seem to think so. Is it overly expensive? Yes. The Gap's Athleta line is cheaper and functionally equivalent for probably 99% of customers. LULU's customers were willing to pay a premium for the brand name and the bragging rights. With the destruction of LULU's popularity, those bragging rights are not worth much. Prices seem sure to fall. Margins will get hurt. LULU may make a slight comeback; but it's done. Stick a fork in it; and invest in something else. It probably is a good long term short; but I would definitely sell it.

Women's pride in both the products and the company ("a company making products for women run by women") has been destroyed. Laurent Potdevin will not restore that. If I were a woman, I might buy the cheaper Athleta brand pants, especially on sale for half or less the price of LULU's products. If I wanted to brag about the brand, I might buy Under Armour or Nike. I would be leery that LULU might find yet another way to insult me and/or my body. On top of all this, LULU's guidance for growth was flat for Q4 2013. This last is a death knell for a momentum growth stock. It is usually the straw that breaks the camel's back. I wouldn't invest in LULU. There is too likely to be large future selling pressure.

The two year chart of LULU provides some technical direction.

(Click to enlarge)

The slow stochastic sub chart shows that LULU is oversold near term. The main chart shows that LULU has been in a sideways channel pattern for much of the last two years. Momentum traders quickly tire of stocks that exhibit this kind of behavior. Investors should expect LULU to lose the cachet of the momentum investors. With short interest at 15.80% of the float, this could be a very bad thing. With a PE of nearly 32 and flat guidance for Q4 2013, LULU is far overpriced fundamentally too. In addition LULU has seen -12.20% insider selling over the last 6 months. I wouldn't invest in LULU. There is too likely to be large future selling pressure. The CAPS community seems to agree with me. It gives LULU a one star rating (a STRONG SELL). Aggressive traders may wish to consider LULU for a long term short position. Prudent investors probably just want to sell LULU.

Note: Some of the above fundamental fiscal data is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short 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.