After hitting its highest price level of $82.28 in June 2013, Lululemon Athletica's (NASDAQ:LULU) stock price started declining. Since then, the stock has depreciated by 40% and is now at $49.26, its lowest level in the last two years. On January 13th, 2014, the stock sank by more than 16% as the company's Chief Financial Officer revealed that the store traffic and sales have dropped "meaningfully" since the beginning of 2014.
Based on this performance and assuming that the trend will continue through the remainder of the month of January, the company has once again lowered its earnings outlook for the fourth quarter of FY13. The fourth quarter revenues are anticipated to be in the range of $513 million to $518 million compared to the range of $535 million to $540 million that was anticipated in the previous guidance.
The comparable store sales are now projected to be in the negative low-to-mid single digits on a constant dollar basis, whereas in the previous guidance provided the comparable store sales were projected to remain flat. The company has never operated in an environment of declining sales demand before.
Despite modifying the outlook, the anticipated net revenues are still higher than the revenues in the fourth quarter of FY12 by 5.8% to 6.8%. Diluted per share earnings are now expected to be in the range of $0.71 to $0.73 per share compared to $0.78 to $0.80 per share expected in the previous guidance.
The company's operations are affected by the seasonality effect, and its annual sales are more heavily weighted towards the fourth fiscal quarter due to the holiday season. Therefore the negative low-to-mid single digit comparable store sales in the month of January could heavily impact its full year earnings.
Lululemon's revenue grew by approximately 21% during the first three quarters of 2013 compared to the net revenues of the first three quarters of 2012. Although the revenue growth is positive, it plunged compared to the previous year's growth and reflected the fact that the company is heading towards its maturity stage. The chart below shows the revenues of the first three quarters over the last five years.
Source: SEC Filings
Besides that, the company's 2013 sales growth was also hit by the negative press and negative word of mouth regarding the fact that its signature stretchy yoga black pants were too sheer. Apparently, consumers had bad experiences using these pants. The problem got worse when Lululemon's founder, Chip Wilson, blamed customers for the quality problems rather than admitting the company's fault.
According to analysts, poor customer relations are the main culprit behind this negative comparable-store sales trend. The company engages arrogantly with its customers and never tries to launch customer-friendly policies. Apart from that, the increasing competition from rivals Nike (NYSE:NKE), Under Armour Inc. (NYSE:UA), and Gap's (NYSE:GPS) Athleta brand is also challenging the company's top line growth.
The North American athletic apparel industry has a bright outlook for the coming two years (2014 and 2015). To avail this opportunity, Lululemon's management needs to change its behavior towards customers and needs to improve the quality of the products in its portfolio
The Chief Financial Officer has announced that the company now conducts extensive and constant testing of all its fabrics and that some additional investments will be made in order to improve product quality. Therefore, I believe that over the next few months of 2014, the company will again start experiencing positive growth in its comparable-store sales.
Lululemon has enjoyed several years of extremely strong sales growth and the highest-ever operating margins. The table below shows a significant difference in Lululemon's margins compared to the overall industry margins. However, these are now closer to the industry figures as the company's margins have begun deteriorating.
During the first three quarters of 2013, Lululemon experienced a 2.74% increase in its cost of selling goods as a percentage of sales, which reduced the company's gross margin compared to the first three quarters of 2012. Selling, general and administrative expenses during this period rose 22.54% YoY, and along with the lower gross margins, caused a decline in the company's operating margin by 3.13%. The company's net margin, as a result of declining gross and operating margins, fell 2.44%.
Balance Sheet Analysis
Lululemon has a very strong and healthy balance sheet, as it has highly appreciable current and quick ratios and absolutely no debt. The ratios are also considerably better than its rivals' averages, reflecting the fact that the company has a very strong liquidity position and is in a position to easily meet its short-term obligations.
Lululemon Atheltica currently does not pay dividends to shareholders and the company does not have plans to initiate any share repurchase program in the near future. The only way for investors to earn profit on their investments is through stock price appreciation. However, as the company's stock has depreciated by approximately 32% in the last year, there is no way for investors to earn profits by investing in Lululemon's stock.
Lululemon's stock is clearly overvalued on the basis of price multiples as all of the four ratios are greater than the industry average. The company's stock has already incorporated the value delivered through sales, earnings, and cash flow growth, denoting the fact that it does not have the potential to grow further. Therefore, the stock currently has a downside potential.
Despite lower comparable-store sales and lower earnings guidance for the fourth quarter of 2013, Lululemon is in good financial health. The company has impressive margins and a very strong balance sheet compared to the industry averages, but since it does not pay satisfactory returns to investors in any form, I would not recommend buying the stock.
However, I expect that by implementing its new quality enhancement strategies, as announced by its CFO, the company could add growth to its top and bottom lines in the coming future. This would add value to its stock price, but may take a long time. Until then, the company's stock does not present itself as an attractive opportunity to invest in.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article.