Lululemon Athletica: Insulated From Consumer Spending Woes

Lululemon (LULU) reported earnings for their third quarter Thursday and blew out analysts expectations. While other retailers have been blaming poor performance on weather conditions, this company is proving that proper execution of a growth strategy is much more effective than relying on weather patterns for store traffic. For a background on LULU and their expansion plans see my previous post on Lululemon from September.

For the quarter ending October 31, LULU posted sales of $66.2m which is 84% above Q3 2006. Net income was $11.8m versus 4.7m last year and the earnings per share came in at $0.11 for the quarter which brings them up to $0.23 year to date. The per share numbers may be a bit small but the growth trajectory is tremendous and management gave us every reason to believe these growth prospects remain. Management is guiding for full year earnings of $0.40 to 0.42 which is significantly higher than previous guidance of 30-35 cents. While the company does not give guidance for 2008 until its fourth quarter conference call, I think it is fairly safe to expect that consensus numbers at 65 cents will be too conservative.

Store openings continue to be strong with the company completing 10 additional openings in Q3 which brings the total for the year to 17. The company expects to open an additional 10 stores this quarter and stated in the call that 8 have already successfully opened. Guidance for next year is an additional 30-35 and leases have been signed for the majority of those store openings. The company has a unique strategy of opening showrooms in various parts of a potential market to test demand for product and to get the brand in front of consumers in that demographic. When successfully implemented, new stores are much more successful because consumers have already been educated as to what the LULU brand stands for and already have an appetite for the products. Management was asked if they saw particular regions that had better or worse reception to new stores and stated that so far the showroom strategy has paid off and they are seeing strong demand in all demographic areas.

An exciting sales driver that was introduced this quarter is womens outerwear otherwise known as coats and jackets. It appears that this new product line got a “warm” reception (sorry - bad pun) as the company expects to sell out of this line in the next 3-4 weeks - much earlier than original plan. While this may look like poor planning on managements part, inventory management is a critical part of any retailer’s strategy and LULU would prefer to keep low inventory and demand buzz alive rather than have excess product and have to mark down merchandise at the end of the selling season. In Q2 the company had inventory levels a bit too tight and sold out of some core brands which may have depressed sales a bit, but an adjustment in Q3 was instrumental in driving such a strong Q3 revenue number. The company will continue to experiment with new product lines including apparel for cycling, swimming and running and potentially some sports accessories given their active lifestyle target customer.

Leading into the earnings announcement, many had concerns after reports came out that there was no evidence that the VitaSea product had actual seaweed in the fabric. The company had marketed the fabric as an organic material with seaweed content that would release amino acids and vitamins directly into the skin while working out. Management has stood by their quality and is investigating the allegations, but also notes that VitaSea only makes up about 1% of revenue and they have not seen the news have any detrimental effect on the demand for their products. While an accusation such as this could have a damaging effect on a company that relies so heavily on reputation and word of mouth, it appears that the public relations department has done a good job of addressing the concerns and maintaining a healthy image.

I have a small position in LULU and am interested in buying more. The stock has pulled back technically and while it is still expensive compared to current earnings, it is reasonable to expect that the company will continue to execute on their aggressive growth strategy. The name will have a decent amount of volatility as we work through market swings and concerns about the consumers ability to spend, but high net worth clients are LULU’s bread and butter and I would not expect these customers to quit spending any time soon.

Disclosure: Author has a long position in LULU

Comments

[Love to short:]

Great article. I too am long the stock with a cost average of 38. You are right, multiples are high, but their ability to keep limited inventory while continuing to aggressively open more stores will prove to be a great strategy. Again, solid article that provides very detailed insight.

2007 Dec 04 12:24 PM