Lululemon Is Ditching The Downward Dog For A New Bull Position

| About: Lululemon Athletica (LULU)

The past 13 months have been very difficult for lululemon (NASDAQ:LULU) investors. The stock began the year above $70, fell into the low $60's because of quality issues with their popular black luon pants, then rallied back into their Q1 2013 earnings release on June 10, only to be hammered back down because of the announcement of Christine Day stepping down as CEO. Things continued to get worse for investors when management revised their full year outlook down twice in two months: first during their Q3 2013 conference call in December and then again in January ahead of their presentation at ICR XChange. Management began the year with an estimate of $1.642 billion dollars in sales and diluted EPS of $2.08 for fiscal year 2013, but now they believe that the company will earn 10% less, $1.88 per share, on sales of $1.586 billion.

The company underwent dramatic leadership changes during the year. The first change took place on February 4th, 2013 with the appointment of Robert Bensoussan to the Board of Directors. He expanded the number of board members to 11 and is intended to help guide the company through its international expansion. He currently serves as director of Sirius Equity, a principal investment firm based in the UK that invests in retail luxury brands throughout Europe. "In the past four years, Sirius has invested in UK shoe and clothing retailer LK Bennett, Italian sportswear retailer and wholesaler Jeckerson Spa and the UK's, Europe's largest online beauty retailer." He also sits on the boards of 4 other companies throughout Europe and previously served as CEO of a privately held luxury shoe retailer.

The next change took place on April 3, 2013 with the resignation of Sheree Waterson as Chief Product Officer. Ms. Waterson had led the product organization since 2008 and has taken a lot of the blame for the luon pants disaster. After her departure her role was split into two positions: Senior VP of Sourcing and the Chief Product Officer. Jennifer Battersby was appointed Senior VP of Sourcing in September after working as a lululemon consultant for the prior 4 months. She has more than 20 years of industry experience, the majority of which was spent with Mast Industries, most recently as SVP of Victoria's Secret production in Asia. Then in October the company appointed Tara Poseley to the position of CPO. Ms. Poseley also has significant industry experience, 25 years, and most recently worked as President of Kmart Apparel (NASDAQ:SHLD). Before that she spent 15 years working for a lululemon competitor, The Gap (NYSE:GPS), which owns the Athleta Brand.

The shakeup continued in June when Christine Day announced that she would be stepping down as CEO of the company. She said that her departure had nothing to do with quality issues and that she wanted to spend more time with her husband. (It has now been announced that she will be taking over as CEO of Luvo, a company that sells healthy frozen meals.) In December, lulu completed their search and named Laurent Potdevin, the former CEO of Toms Shoes, as their new Chief Executive Officer. Mr. Potdevin is Swiss-born and began his career at the French luxury powerhouse LVMH, before serving in a variety of roles at Burton Snowboards including COO and CEO. The company believes that he will bring "a deep understanding of premium brands, athletic apparel, technical products and innovation" to the company and they made a short video to show how he fits in with the culture.

The announced resignation of Chip Wilson, lululemon's Founder and Chairman of the Board, on December 9, 2013 was the final major change of the year. Before the annual meeting in June he will step down from his role as Chairman and take a normal board seat, allowing Michael Casey to take over. This may be happening because the company wants to distance themselves from Mr. Wilson and his numerous public gaffs, most recently telling Trish Regan that some women are too big for lululemon's pants.

Any company that has undergone this many changes in such a short period of time is certain to stumble, and that could be what we are seeing in lululemon's most recent estimate revision. The company went 7 months without a CPO, has had a checked-out CEO since June and a Board focused on filling positions and putting out fires created by its chairman. The company reported late product deliveries, uneven product flow, and the cancellation of purchase orders as the major causes of lost sales incurred during the third quarter, with that expected to continue into the fourth.

Lululemon has consistently reported above the high end of their own EPS estimates quarter after quarter over the past 5 years. (Including a 4 cent beat in both Q2 and Q3 of 2013.) Their newest revised estimate for fourth quarter EPS is between $0.71 and $0.73 per share, down from an original $0.80 given just 32 days earlier.

What happened to lulu during these 32 days that caused them to reduce their projected net income for the quarter by more than $10 million? The company's CFO, John Currie, stated that "we were on track to deliver on our sales and earnings guidance through the month of December; however, since the beginning of January, we have seen traffic and sales trends decelerate meaningfully. Based on this recent performance and assuming these trends continue through the remainder of January, we are reducing our outlook for the fourth quarter." Lulu's sales were strong through November and December, the holiday season, but took a big enough hit during the first 12 days of January to knock $10 million in earnings from the company's quarter. I believe there are two possible explanations for this. First, the incoming CEO has immediately reduced expectations to lower the bar and increase the value of their options. Incoming management teams have an incentive to report a "Kitchen Sink" quarter to reduce guidance and drive their stock price down. This will allow them to blame the performance on the old management team and take credit for the recovery.The second explanation could be the polar vortex that kept many shoppers bundled up under blankets on their couches in January. The company's stores are overly concentrated in the Northern part of the continent, with nearly a quarter in Canada and many more in the metropolitan cities of the North Eastern United States. Consumers may have been literally too cold to leave their houses (many companies have been blaming the weather for weak January sales).

There is no doubt that 2013 has been a bad year for lululemon's investors, but despite all of the shakeups the company is positioned well for long-term growth. The company currently operates 247 stores throughout the US, Canada, New Zealand and Australia and opened 21 new locations during the last quarter. The company has been increasing the store count at a compound monthly growth rate of 5.4% over the last 3 years and shows no signs of slowing down. The company finished the quarter with 63 showrooms which they use to test new markets and develop clientele through community activities, setting the stage for future retail growth.

Of the 63 showrooms the company operated at the end of Q3 five were in Asia and seven were in Europe. The company has been slowing preparing for its international expansion and has plans to open three more international showrooms during the 4th quarter along with their first full European store in London during the 1st quarter of 2014. The changes the company has made to its board and executive team during 2013 should position the company well for these new international markets. The company's CEO is multilingual, as is its newest board member and both have experience operating in the European luxury market. The company's new SVP has experience working in Asia, while its new CPO is experienced in operating the product department for a retailer with over a thousand locations.

The past year was rough for lululemon investors, but the future is still bright for this company. Lululemon's executive team has been retrofitted with the tools that they will need to take the company into its next phase of expansion. They have the third highest retail sales per square foot in the US, are just beginning their international expansion, are building out a concept targeted at younger girls and are starting to attract more male customers. I expect lululemon to leave the mistakes of 2013 behind them, along with all the headlines and puns, and continue on their mission to provide athletic clothing that people enjoy wearing.

Disclosure: I am long LULU. 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.

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