Competition Is Starting To Stretch Lululemon

| About: Lululemon Athletica (LULU)

Lululemon (NASDAQ:LULU) is an amazing growth story. It was one of the first companies to really create quality, stylish workout clothes, especially with yoga. The company focused on the way people, especially women, want to look in the gym. LULU grew by leaps and bounds, starting in Canada, then opening up stores in the United States, and now opening stores in Australia, the UK and now Hong Kong. It's often tough to predict how well a company will do overseas, and those countries have their own versions of stylish athletic clothes. I believe the Lululemon growth story is coming to an end, and the company's PE will fall to the 30s by the end of the year. This prices the stock today at the mid-50s. If guidance is reached for 2012 of $1.60, and the PE falls to 35, that would value the company at $56 per share. The following are big reasons why:

Competitors Are Endless

This latest quarter, Lululemon's online sales almost tripled, accounting for 13.5% of revenue vs. 7.4% a year earlier. This shows that online sales are a significant part of the company's revenues. However, if you do a Google search for "stylish yoga clothes," "designer workout clothes," "yoga clothes for women," "men's workout clothes," "stylish gym clothes for women" or any variation of those types of words, you aren't going to find a single link that goes to buy Lululemon products. Even if you flip to the next search pages. Some brands I do see are:

Lucy, Zappos, Prana, Bravada, Impact Fitness, Zella, Rogiani, Kims Body Wear, Athelta, TonicGear, Long Tall Sally, The North Face, Victoria's Secret Yoga, Bia Brazil, Activewear USA, Under Armour.

Recognize some of these brands? These are about half of what's online, but the point is clear: there are other games in town. This is dangerous for the company's future, because while the above brands mostly sell online, with growing demand, they can then open stores and directly compete with Lululemon in the brick and mortar space. Gap is expanding its Athleta brand and is opening many new stores this year that will directly compete with Lululemon.

Also, it's clear that Lululemon isn't investing in online advertising, and I think that's a mistake. Just looking at's (NASDAQ:AMZN), Macys (NYSE:M), Nordstroms (NYSE:JWN) and even Lululemon's own e-commerce growth shows that many people prefer to buy clothing online.

I have heard people make the bullish argument that if you go to gym in big cities, everywhere you look women are wearing Lululemon clothes. Well, this is a company that is now pulling in over a billion dollars in revenue per year, of course there are going to be lots of people wearing the clothes. But that doesn't mean that they're going to keep buying them. When Lululemon was growing, then maybe a PE of 40 or 50 was justified. Now that they have reached the later innings of the company, with a $9 billion market cap, there's no reason to expect the same growth.

Any one of Lululemon's competitors can break out and become the next hot workout clothing line. Then where will Lululemon's P/E be? Probably about the same as Green Mountain Coffee Roasters. Do you see the resemblance between the two companies? Look at what happened to Tempur-Pedic (NYSE:TPX). Eventually companies with innovative, but replicable, products get challenged by competition.

The Marketing Image Is Too Narrow

Lululemon has created a great, specific niche for women's workout clothing, mainly yoga clothes. Now with its size and unsustainable P/E ratio, it's looking to branch into other areas to push for continued growth. However, in its early stages, the company didn't realize it would grow so much, so it focused on marketing only to women doing yoga. Now, the company is having a harder time adjusting its image to market to a broader demographic.

For example, look at the name: Lululemon. That has a feminine ring to it. Then look at the logo. The logo is more feminine than the name. It's curvy, representing women's curves, and looks like a women's head with long hair. For this same image reason, Lululemon is going to have a hard time selling other accessories, like outdoor clothing and gear. The outdoors isn't the company's forte.

A Growing Inventory

In the past, Lululemon clothes were sold so quickly there was a constant shortage. Now, the company said it's making sure inventory is fully stocked and that no sales are lost. However, this also comes at a price of markdowns and lower gross margin. The excess inventory also could partially be due to the growing competition. In the Q1 2012 conference call, Lululemon's CFO said:

we expect gross margin to be below 55% in Q2. We expect some gross margin decline versus the second quarter of 2011, driven primarily by the same reasons experienced in Q1, higher product cost due to innovation, construction and more normalized markdowns due to balanced inventory levels.

Gross margins are declining due to both higher product cost, and the need to markdown clothes that aren't selling well. With all of the above factors, this could be the last year that Lululemon experiences more than 10-15% annual growth.

Rating: Moderate Sell

Disclosure: I am short (LULU).