Lululemon Brand, Cult At Risk Following Seaweed Report

A report suggesting some of Lululemon Athletic Inc.’s (Nasd: LULU) clothing does not contain seaweed as the company claims it does sent the shares down, then up, on Wednesday. But it remains unclear whether the company is fully informed and if these claims are valid.

Blackmont Capital analyst Barbara Gray spoke with management at the Vancouver-based yoga apparel retailer to try to get the facts. This is what she learned:

- Lululemon has been contracting lab testing to Switzerland-based SGS, the world’s largest control and inspection company, for more than a year.

- Test results in July stated that VitaSea fabrics meet specifications.

- Gemany-based supplier Smartfiber said SeaCell emits amino acids into skin. The company also audits its factories.

- Italian clothing company, Adea, launched a SeaCell Activewear line in October.

- VitaSea is in only 3% of Lululemon’s products.

- Management will honour returns but does not plan to stop selling them.

So what does Ms. Gray think about all this? She said Lululemon’s strong brand and cult following could be tarnished if its claims prove to be false. This could expose it to pricing risk and put its aggressive expansion plans in jeopardy, she told clients in a note.

Ms. Gray maintained her “hold” rating and US$41.50 price target on Lululemon shares, but noted that she values its existing business at only US$5.71 per share.

RBC Capital Markets analyst Howard Tubin estimates that VitaSea only contributed a percentage of Lululemon’s sales in the low single-digits. He also feels that the retailer’s success is largely about the fit of its products.

“We believe the attraction for customers shopping at Lululemon is the fit and comfort, and most importantly, how they look in their clothes,” the analyst said in a note. “The garments’ form-flattering silhouettes will continue to drive customers, more so than any one particular fabric enhancement.”

Mr. Tubin calls these fabric issues “a back-office hiccup...that speaks to concerns that some investors had about whether the back office is ready to support the expected growth ahead for LULU: something management will continue to work on.”

He continues to rate the shares at “outperform.”