Have Lululemon Shorts Been Misled By A Loonie?

Aug.10.12 | About: Lululemon Athletica (LULU)

Some simple analysis shows that Lululemon (NASDAQ:LULU) longs may be receiving a much needed boost from an underappreciated, yet obvious, driver of the share price -- the Canadian dollar, aka the loonie.

Followers of the stock need not be reminded how in June, despite releasing better-than-expected Q1 2012 earnings, the stock plummeted 12% and began a downward spiral that has only recently shown signs of bottoming. The fact that the company did not significantly increase its full-year revenue guidance despite a meaningful beat in the first quarter was taken as the first signal of a slowdown, and an inevitable harbinger of doom for a pricey consumer momentum stock. In reality, as shown in the table below, management simply raised its revenue forecast for the full year by $20 million (almost exactly the amount of the Q1 beat), thereby maintaining its previous expectations for the remainder of the year.

In its constant effort to concoct a simple explanation for any significant stock price move, the financial press made several references to Lulu's results as evidence of weakening demand for high-end consumer items. There was also a lot of focus on management's somewhat confusing comments about the tradeoff between product innovation and "chasing sales," and the view that growth opportunities would be back-ended to the fourth quarter.

What’s surprising, however, is the lack of focus that was given to the fact that management went out of its way to stress how the weakening Canadian dollar significantly impacted the formulation of its revised guidance. The two references to the importance of the FX rate made by CFO John Currie were as follows:

1. This guidance assumes a lower Canadian dollar at $0.97 to the U.S. dollar vs. par in our previous guidance with the reduction in revenue on currency translation offset by slightly higher store productivity and e-commerce performance.

2. Again, our outlook assumes the Canadian dollar at $0.97 to the U.S. dollar compared to $1.03 in Q2 of 2011.

Based on Lulu's 10-Q, 35% of sales were derived from Canada and another 5% from outside North America, the bulk of which is Australia. Given that the Australian dollar was tracking the Canadian dollar lower at the time, we can simplify our calculations by assuming 40% of sales could be impacted by the move in the Canadian dollar exchange rate. The calculations below show that were it not for this change in FX assumption, management would have raised its full-year revenue guidance by roughly an additional $12.5 million for a total of $32.5 million, or 2.5% of its original forecast.

The mathematical implications that the movements of the Canadian dollar have for Lulu's earnings may seem too small to matter, but as the Q1 2012 fiasco has shown us, this stock is highly sensitive to even the slightest shift in the perception of revenue growth momentum. It would also seem fair to assume that the FX trend may have put enough of a dent in management's confidence for it to strike a more cautious tone than it may have otherwise.

During the week prior to the results announcement, the Canadian dollar appeared to be in free-fall, hitting a year-to-date low of $0.96 to the U.S. dollar. At that point the company would have been facing some significant headwinds for its Q2 2012 year-over-year comps, with the Canadian dollar having been worth 7% more at $1.03 to the U.S. dollar in Q2 2011.


The loonie has abruptly reversed course since the company's Q1 2012 earnings call. The actual average exchange rate in the second quarter was $0.98, only slightly higher than the $0.97 assumption used in the revised guidance, but as of the time of writing this it has reached nearly $1.01, or 4% higher than the assumed rate.

Barring another reversal in this trend in the coming weeks, we can conclude that FX should be one factor supporting a more upbeat tone from Lulu come its September conference call. My personal investment horizon is much longer term, and my reasoning for getting long Lulu has more to do with the huge growth potential that I see for the brand in the as-yet untapped Asian market, but I will save that case for a future article.

Disclosure: I am long LULU.