5 Red Flags at Lululemon

Dec. 3.07 | About: Lululemon Athletica (LULU)

The controversy over whether some of its clothes are seaweed-spiked may have put Lululemon (NASDAQ:LULU) on a neon-lit map, but even if that were never an issue the company still flashes plenty of other red flags, including:

Red Flag No. 1: Early insider sales. When the company went public in the U.S., selling 18.2 million shares for $327 million, 78% of the proceeds when to insiders who pocketed $252 million. Always a red flag when, right off the bat, venture investors are looking for ways to bail less than two years after they’ve bought into an unproven concept. It’s not like the company’s share were so illiquid that the insider sales would create a better float (sometimes the excuse given for large, early insider sales.)

Red Flag No. 2: Share count. Even without their sales, the company debuted with tens of millions of more outstanding shares (thanks to a restructuring from its prior Canadian structure) than the typical retail IPO. With 72.6 million shares, the simply doesn’t have the earnings leverage that young, growing companies often get. Consider that every $1 million in earnings at Lululemon translates into 1 cent per share.

Compare that with Deckers Outdoors, with just 12.9 shares, which results in an additional 8 cents per share for every $1 million, or Zumiez with 28.7 shares, which would get 3 cents. With its stock already trading at 90-times this year’s guidance, to genuinely justify its current valuation Lululemon would have to roll out substantially more stores the current plan and hope to generate huge, genuine upside earnings surprises – not the kind created by a lower tax rate, as happened in the past two quarters.

Red Flag No. 3: Valuation. From a valuation standpoint, its value is higher than Zumiez and nearly as high as Deckers Outdoors, both of which have considerably higher sales.

Red flag No. 4: Competition. There are no barriers to entry to Lululemon’s business. Victoria’s Secret, among others, is getting into the act.

Red Flag No. 5: Management integrity. Other than to go on CNBC and say he “refutes” my claims that he exaggerated on his resume, CEO Bob Meers has yet to show proof that I’m wrong. As I pointed out on Friday, he has yet to return my calls to show proof. I guess he thinks this will blow over and people will soon forget. I won’t.

The beat goes on….