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Shares of Lululemon Athletica (LULU) fell 8.8% on Thursday after the retailer of yoga and fitness apparel reported its first quarter earnings. Shares fell on the back of a weak second quarter outlook.

First Quarter Results

Lululemon reported strong first quarter results. Net revenues increased 53% on the year to $285.7 million, driven by 25% comparable store sales growth. Net earnings grew 39% to $46.6 million, or $0.32 per diluted share. Gross margins fell by 370 basis points to 55.0% as a percentage of revenues. Direct to consumer revenue growth rose an incredible 179% to $38.4 million, now comprising 13.5% of company-wide revenues.

CEO Christine Day said:

Our strategy to increase inventory levels led to strong revenue growth and earnings performance in the first quarter as our guests responded well to our spring styles and colors.

Outlook

For the second quarter of 2012, the company expects revenues to come in between $273 million and $278 million. Comparable store sales growth is expected to come in the low double digits, compared to 25% growth in the first quarter. Diluted earnings per share are expected to come in between $0.28 and $0.30 per share. Last year, the company reported second quarter revenues of $212 million and earnings per share of $0.26. For the full year of 2012, net revenues are expected to come in between $1.32-$1.34 billion, with diluted earnings per share of $1.55-$1.60

Valuation

Lululemon ended its first quarter with $424.3 million in cash and equivalents and operates without any meaningful debt. The net cash position of $424 million values the operating assets of the firm at $8.8 billion. This values the company at an incredible 8.8 times annual revenues and 48 times 2011's annual earnings.

Currently the company does not pay a dividend.

Investment Thesis

Shares of Lululemon have seen a great long-term performance. Trading from lows of $3 in 2009, shares have boomed amidst a trend for high-end yoga and fitness outfits. Shares ended up peaking at $81 in the beginning of April, but have ever since corrected some 20% to $64 after Thursday's price decline.

While the company makes great products, has shown enormous growth and is financially very strong, the valuation has grown too quickly. On the back of the full year outlook of 2012, the market values the firm at 6.8 times annual revenues and 38 times annual earnings. While the firm has an excellent business, I would not touch their shares any time soon. Years of margin growth have resulted in net profit margins of 18.4%, which is clearly unsustainable in the long-term as competition inevitably will kick in.

It only takes one profit warning for a key third or fourth quarter, which could result in lower expectations for long-term margins. Such an event would inevitably be accompanied with a lower valuation multiple, creating a "double whammy" for shares, and possibly, a second Tempur-Pedic (TPX).

Source: Why Lululemon Could Be The Next Prime Short Candidate