Shareholders in athletic apparel maker Lululemon Athletica (NASDAQ: LULU) have undoubtedly been unhappy with the company's negative stock price performance over the past year, down more than 45%, which seems to have been the result of slowing profit growth and a contraction in the multiple that investors are willing to pay for its operating profit, as illustrated in the below table. The company's profitability has been pressured by the costs of increasingly promotional selling behavior, due to heightened competition in the women's apparel area from athletic apparel industry players, like Under Armour (NYSE: UA) and Nike (NYSE: NKE).
|Total Revenues ($ Millions)||1,591||1,370||1,001||712|
|Revenue Growth (%)||16||37||41||57|
|Adj. Operating Profit ($ Millions)||391||376||287||182|
|Adj. Operating Profit Growth (%)||4||31||58||110|
|Market Cap. @ Dec. 31 ($ Millions)||6,809||8,566||5,139||3,652|
|P/Adj. Operating Profit||17.4||22.8||17.9||20.1|
Source: Lululemon Athletica 10-K (2013, 2012, 2011)
However, Lululemon Athletica's share price seems to have found a bottom recently, partially due to speculation regarding company founder Chip Wilson's plans to try to regain control at the company, speculation that was proven to be misplaced when Mr. Wilson sold half of his sizable stake to investment firm Advent International. Also likely helping Lululemon Athletica's stock price was the announcement of a new $450 million stock repurchase plan, roughly 8% of its current market capitalization. So, is it time to bet on a higher market value for the company?
What's the value?
Lululemon Athletica has built a strong franchise in the athletic apparel space by focusing on women's desire for comfortable, yet fashionable, attire for use in their athletic pursuits and active lives, a focus that has won it a loyal, growing customer base. The company has also anecdotally benefited from its premium brand positioning, which has allowed it to generally sell products at premium price points, ensuring a solid level of operating profitability, which averaged roughly 25% over the past five years. Consequently, Lululemon Athletica enjoyed solid cash flow during that period, fueling an expansion of its store base and a strong top-line growth trajectory, up more than 251%.
That favorable trajectory, though, took a bit of a hit in the company's latest fiscal year, due in part to a well-publicized quality control problem with its popular black Luon pants. While Lululemon Athletica's quick decision to recall the affected products was undoubtedly the right move from a customer service perspective, it saddled the company with higher costs, including large inventory write-downs, which led to a 290 basis point decrease in its gross margin. The net result for Lululemon Athletica was lower than expected growth in adjusted operating income, up 4.0% during the period, a performance that clearly weighed on its stock price.
Fighting for market share
Of course, the question for investors is whether Lululemon Athletica can raise its profit growth trajectory back to a double-digit level, thereby providing a solid foundation for a higher market valuation. Unfortunately, things are not looking great in that respect based on the company's performance in its most recent fiscal quarter, evidenced by a 5.9% increase in operating income, a performance that did not jive with investors' expectations, judging by the subsequent decline in its stock price.
Part of Lululemon Athletica's problem is that its major competitors seem to view the women's apparel segment as a key part of their future growth plans. Under Armour, for its part, generated roughly $500 million from the sale of women's apparel in its latest fiscal year, nearly 20% of its total sales tally. More problematic for Lululemon, Under Armour's aspirations in the segment only seem to be getting larger, highlighted by its recent introductions of the Armour Bra and UA Studio product lines, which were supported by a targeted media campaign.
Likewise, Nike seems to have its eye set on greater sales from female customers, a subset of its customer base that accounted for roughly 21% of its total sales in its latest fiscal year and generated a 10.6% increase in sales compared to a 7.1% gain in sales for male-oriented merchandise. The company had already been actively investing in greater product selection for its female customers, including incorporating its Dry Fit technology into its pants offerings, the product category that put Lululemon Athletica on the map. However, Nike's growing sales success with its female-oriented merchandise offerings will likely lead to even greater product development and more support from its global marketing and brand management machine, putting further pressure on its smaller competitors.
The bottom line
A less favorable growth profile has led to a difficult period for Lululemon Athletica's stock price, which has underperformed the market averages over the past year. Unfortunately, it is hard to see things changing in the near term, given that management has acknowledged that the current year is a transitional period for the company and has forecasted that its FY2014 adjusted EPS will be between $1.71 and $1.76, below the result achieved in FY2013. As such, there seems to be little forward momentum at Lululemon Athletica and investors should take a pass on this apparel manufacturer.
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