Lululemon Stretching For Growth

| About: Lululemon Athletica (LULU)

Based out of Vancouver, Canada, Lululemon Athetica (NASDAQ:LULU) is a major player in the athletic apparel segment, with a focus on the sophisticated and active female yoga enthusiast. Lululemon opened its first store in 2000 and now operates 180 stores in the United States, Canada and Australia as well as showrooms in London and Hong Kong, paving the way for expansion in Europe and Asia.

Breaking with traditional retail practices, Lululemon has used scarcity and urgency to maintain higher margins and limit brand-dilution; discounting by limiting inventory, a strategy which concerns some investors who fear that the result is lost potential sales. A concern which is at odds with the numbers as Lululemon generates upward of $1,800 is sales per square foot, more than triple what Neiman Marcus (Pending:NMG) does. By limiting the number of available items, Lululemon drives shoppers to buy right away rather than wait for a sale or otherwise postpone making a purchase. Staples and basics such as black yoga pants are stocked more heavily to ensure that there is always something available.

In the past three years Lululemon boasts nine quarters with at least a 30% increase in sales from the same quarter of the previous year. Total revenue in Q4 2011 was $371.5 million, an increase of 51%, with profits topping $73 million, up from $54 million during the same quarter of 2010.

As the company pushes forward with rapid expansion in the US market, increasing costs due to staff salaries, raw materials and markdowns were blamed for slipping margins, adding to investor concerns. Lululemon management seems undeterred, sticking to the belief that its unique connection with customers is the secret sauce to success.

Even as the company expands, Lululemon's management rejects data crunching and cold analysis in favor of on the ground listening and personal engagement, strategically placing staff folding tables within earshot of dressing rooms so that customer comments and complaints can be overheard and reported to managers. While this drive to connect directly with customers is a powerful marketing tool, especially with women, they are rapidly approaching the point where investors will look much more closely at its performance as a growth stock.

For the full year, the company now forecasts revenue of $1.32-billion to $1.34-billion, and earnings per share of $1.55 to $1.60. In March, it had projected revenue of $1.3 billion to $1.33-billion, and earnings per share of $1.50 to $1.57. By highlighting the seasonality of its sales in its last earnings call, they are asking to be valued differently, and this is why the market punished them after the earnings call. It's not possible to maintain a P/E of 60 and not be completely focused on growth.

Lululemon's brand positioning as an upscale specialty athletic retailer could play well in Asia where the yoga craze is beginning to catch on among middle and upper class women, who are fiercely brand-conscious and are willing and able to pay a premium for quality brand names. But, a call placed to investor relations informed me they had not concrete plans for Asia yet. So, again, is this a company whose management is focused on growth or its image? If it's the former then it is past time for them to be moving on markets like London, Paris or Shanghai and not a ninth store in Florida.

As online shopping continues to grow and Lululemon continues to expand in the US, it remains to be seen whether they will build new physical stores or adopt a showroom model in support of its e-tailing, where fewer physical locations provide branding and on the ground street cred. Online sales have nearly tripled in the past year but they still represent only 13.4% of net revenue. And this would also tie in with adding showrooms in Europe as well as the one in Hong Kong. Something has to continue to create the image to justify not only $80 yoga pants but a stock price which says they're planning on finding every woman willing to pay that price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.