Lululemon (NASDAQ:LULU) reported earnings last week. Things to note:
- Revenues rose 15%, net income rose 11%
- Comparable store sales increase 5% and 10% on a 'constant dollar' basis
Funny thing is management of retail companies love the 'constant dollar' comparisons when the ball falls in their park. I've yet to see one report inventory increases on a 'constant dollar' basis. Cash from Operating Activities fell 6% because inventories rose a staggering 37% y/y. Gross margins fell from 50.86% to 48.4%. Management says that:
We are in fact seeing inventory levels rebalance with sales now that we are deep into Q1, so we remain confident that our inventories will be well aligned with forward sales at the end of the quarter. (Source: Q1 Transcripts)
Gross Margins are not going to stay stable while inventories move in line with sales. The problem Lululemon faces is secular. They are getting undercut by competitors selling the same apparels for lower prices. Although LULU is forced to cut prices, they are attempting to keep that to a minimum for brand image purposes. One of two things will happen:
- Gross Margins fall
- Inventories Rise
Since management says that inventories are in-line with sales, we should expect a fall in gross margins; and voila:
We anticipate gross margin to be approximately 47%. The factors driving this are continued improvements in product margins as we benefit from lower airfreight usage and improved initial merchandise margins. (Source: Q1 Transcripts)
They guided gross margins down to 47% from 51.4% last year! The only way to keep gross margins stable is to pile inventories. The only way to push down inventories is for gross margins to fall. The stock rose 10% after earnings. I'm going to add January 2018 puts to the portfolio. These puts will make up 1%. This means that Lululemon puts will now make up 1.5% of the portfolio. Hopefully the markets do not open with too much volatility.
Disclosure: I am/we are short LULU.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.