Lululemon Athletica - Another Disappointment And CFO Departure Might Create An Opportunity

| About: Lululemon Athletica (LULU)


Lululemon's shares fall again after the company cuts its full-year guidance.

Shares are down 50% compared to last year's highs.

Strong balance sheet and continued growth makes the valuation rapidly more appealing.

Lululemon Athletica (NASDAQ:LULU) reported a solid set of first quarter results. Yet the company lowered the full year outlook and will see its CFO leave the company at the end of the year.

The news triggered a big sell-off in its stock as the announced $450 million share repurchase program could not offset the pain of these news items.

That being said, shares are down more than 50% from their highs, while the strong cash balances create a margin of safety during the current turmoil.

First Quarter Headlines

Lululemon Athletica reported first quarter revenues of $384.6 million, which is up 11% compared to a year earlier. Revenues came in ahead of consensus estimates at $380 million.

The company posted GAAP earnings of $19.0 million, down sharply from a reported $47.3 million last year. GAAP earnings per share fell from $0.32 per share to just $0.13 per share. Adjusted earnings came in at $0.34 per share, beating consensus estimates by two pennies.

Looking Into The Results

Total comparable store sales were up by a percent against easy comparables given last year's issues in the first quarter related to the black Luon pants.

Comparable store sales fell by 4% in constant dollars while direct-to-consumers revenues were up by 25%. Direct-to-consumer revenues came in at $66.0 million, representing 17.2% of total sales.

Gross margins came in at 50.9% which is up a 150 basis points compared to a year earlier. Note that last year's gross margins included a $17.5 million provision regarding the Luon pants, equal to roughly 5% of sales. Adjusting for this, margins were under severe pressure.

Selling, general and administrative expenses were on the rise as well, increasing by 240 basis points to 32.7% of sales. As such income from operations fell by just 90 basis points to 18.2% of sales, but adjusting for the gross margin provisions, the fall in operating earnings was much steeper.

The reason for the GAAP earnings fall is the $52.5 million tax provision which included a $30.9 million tax charge to repatriate foreign funds. Excluding for the tax charge earnings would have come in at $0.34 per share.

Second Quarter Outlook

For the current second quarter, Lululemon expects revenues of $375 million to $380 million, which assumes that comparable sales will fall in the low to mid-single digits, in constant dollars. The outlook is very soft compared to consensus estimates at $387 million.

Earnings are anticipated at $0.28 to $0.30 per share.

Full year sales are seen between $1.77 billion and $1.80 billion based on comparable sales which are expected to increase in the low single-digits in constant dollars. GAAP earnings are seen at $1.50-$1.55 per share. Non-GAAP earnings which exclude the tax repatriation charge are projected at $1.71 to $1.76 per share.

Previously, Lululemon saw its annual earnings as high as $1.90 per share on revenues which could approach $1.82 billion. The company has not factored in the potential positive effects of share repurchases on earnings per share.

Valuing Lululemon

The company ended the quarter with $752 million in cash and equivalents. Lululemon company has no debt, which allows for a very comfortable financial position.

Trading around $38 per share equity in Lululemon is valued around $5.5 billion, which values operating assets at around $4.75 billion. This values operating assets at 2.7 times annual revenues and 19 times forward earnings adjusted for the tax repatriation charge.

Lululemon does not pay a dividend at the moment.

Potvedin Has Been Left A Mess

Under command of the much-applauded CEO Christine Day, Lululemon has been on a tear in recent years, although problems already started under her watch last year.

Incoming CEO Laurent Potvedin has been in his role since January of this year, struggling with the tarnished image, increased competition and challenges of foreign expansion. Today the company also announced that CFO John Currie will leave the company at the end of the year.

The company has been trying to sell men's athletic wear, as well as selling clothes to be worn in more casual settings. Combined with the international expansion and internal disagreements, Potvedin has many fires to fight at the same time.

Potvedin's job is furthermore complicated by the high-profile founder and largest shareholder of the firm, Dennis Wilson. Last year Wilson blamed fat women for the problems related to the see-through pants. On Wednesday, a day before the earnings release, he blamed the board for being focused too much on short-term growth and earnings. Instead Wilson argues that the board should focus on the long-term value of the company and the brand.

Limiting The Pain For Shareholders

To offset the very poor returns which investors have seen, Lululemon announced a $450 million share repurchase program, sufficient to retire roughly 8% of the shares outstanding at $37 per share. Under the details of the plan, Lululemon will take two year's time to complete the program.

The monopoly on the market for lucrative yogawear which the company has created in recent years appears to be broken. Both the internal mistakes regarding the underestimation of competition and quality issues have hit the company hard. Competition from Gap (NYSE:GPS), Under Armour (NYSE:UA) and the likes of VF Corp (NYSE:VFC) is hurting, with competitors undermining Lululemon's premium pricing.

The good news, if any, is the fact that the company continues to foresee full year comparable store sales increase in the low-single digits. This is after the company is guiding for a fall in comparable store sales in the current second quarter. Combined with continued openings, after opening 9 stores in the first quarter to bring the store count to 263, revenues should continue to grow.

The company is facing headwinds from all sides, but after backing out cash and adjusting for the tax impact, shares trade at less than 20 times earnings as the company continues to guide for double-digit revenue growth.

I am much more optimistic now, after being bearish when shares were trading in a $60-$80 range over the past few years. At levels in the mid-thirties, I am willing to pick up the shares as the company clearly has a sense of urgency now which could drive incremental improvements, possibly as early as the second half of the year.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.