How Attractive Is Lululemon For Investment?

| About: Lululemon Athletica (LULU)
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Summary

The company continues to invest money in its online sales channel and is investing extensive amounts to expand its operations geographically.

Lululemon has plans to establish new stores in Hong Kong and the Middle East in the upcoming year while 20 new store openings are planned for Asia and Europe by 2017.

The company reported a strong performance in its online sales during the recent quarter, which is indicative of the fact that its investments in this arena are beginning to pay off.

Lululemon (NASDAQ:LULU) recently reported mixed earnings for the third fiscal quarter yet the stock reported an exquisite market performance. The company has faced some rough times in its recent history owing to supply chain issues, an inability to meet customer expectations, and fierce competition. The company is reorganizing operations, making extensive investments to diversify its revenues geographically, and shift away from traditional sales channels. Although the company faced castigation at the hands of customers and analysts alike, the times ahead seem brighter because of where the company stands today.

Recent Performance

As per the recently ended quarter, the company's top line figure fell short of analysts' expectations but outperformed the estimates on the bottom line end. Revenues for the third quarter increased 10% YoY to $419.4 million compared to Thomson Reuters' consensus estimate of $424.8 million. The company delivered $0.42 per share in earnings during the recently ended quarter compared to analysts' expectations of $0.38 per share. However, note that the company's per share earnings were also cushioned by the repurchase of approximately 1.8 million shares worth $73 million during the quarter.

Although Lululemon beat the consensus EPS estimate, the company did report weaker earnings compared to the figures of the same period last year. Lululemon's profits were reported at $60.5 million compared to $66.1 million reported in the third quarter of the last fiscal year. The weakness in profits is primarily owed to higher cost growth compared to the revenue growth. The company's gross margin shrunk to 50.3% in the recently ended quarter compared to the 53.9% gross profit margin last year. The weakness in gross profit margin trickled down to the bottom line and led to a per share earnings contraction from $0.45 last year to $0.42 in the latest quarter.

Future Outlook

Lululemon's sheer yoga pants earned some bad publicity and cost it millions of dollars. However, the issues seem to be fading away as the company has gotten back on track as evident by its quarterly earnings. The company continues to invest money in its online sales channel and is investing extensive amounts to expand its operations geographically. Investments on either end are going to cost the company heavily, which will further constrict the margins for as long as the expenditures persist without a meaningful revenue generation from these investments. However, the long-term impact is almost always positive given that the investments are well thought out.

For now, a large portion of the company's revenues are drawn from the North American region. The company plans to continue to expand operations in the US and benefit from the improving economy. In addition, Lululemon plans to establish a larger footprint in Asia and Europe. The international diversification in revenues is much needed to ensure rapid growth in the future and would offer risk hedging to some extent by reducing the company's over-dependence on North America. The company has plans sketched out to establish its stores in Hong Kong and the Middle East in the upcoming year while approximately 20 new store openings are planned for Asia and Europe by 2017.

Lululemon reported a strong performance in its online sales during the recent quarter, which is indicative of the fact that its investments in this arena are beginning to pay off. During the recent quarter, comparable sales grew 3% YoY on a constant dollar basis which were driven by the 27% increase in Lululemon's online sales. However, the 3% decline in overall same-store sales offset the positive performance as indicated by the online sales channel. As per the recently ended quarter, online or "Direct to Customer" sales accounted for 18.4% of the top line compared to its 16.3% contribution in the same period last year. The fact that online sales now account for a larger percentage of sales is a testament to the fact that the company's investments are paying off.

Despite the improvement in online sales and expected geographical expansion, the earnings growth is expected to remain constricted for some time in the future due to heavy costs expected to be endured by the company in reference to these investments. For the full fiscal year, the company recently announced an improved revision and narrowed the expected range for per share earnings. Lululemon now expects the per share earnings to fall within the range of $1.74 to $1.78 compared to the previously estimated range of $1.72 to $1.77 per share. However, the company made a downward revision to the revenue estimate owing to the port delays on the West Coast, delayed store openings, and ongoing exchange rate troubles.

Conclusion

Lululemon does not presently pay any dividends to its shareholders but that is understandable since the company is making large scale investments to strengthen its competitive position. Geographic expansion will help the company better deal with economic pressures while online sales channel development resonates with changing consumer shopping behavior. The company's long-term investments look good to me but its attractiveness in terms of immediate investment look dim. With such large investments, it looks unlikely that the company will be able to pay dividends or invest in share repurchases.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.