The Lululemon Decision: What Would A Woman Do?

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By Mark Gomes :

A few weeks ago, an institutional PTT Research customer requested our opinion of Lululemon ( LULU ). After consulting with Jamie Nuss (our Fashion & Trends analyst), we determined that LULU might be doomed to the same fate we see playing out with Coach ( COH ) and Michael Kors ( KORS ).

Yesterday's earnings disaster at LULU had talking heads on CNBC debating whether this quarter was a hiccup or something systemic. With our customer's profits in the bank, we were given the go-ahead to share our analysis, which we believe sheds light on LULU's plight.

Let's start with the contribution provided by Ms. Nuss:

I remember when I first started noticing that Victoria's Secret - a unit of L Brands ( LB ) had workout clothes in its stores. It was at a time when you couldn't get me to wear anything other than Lululemon.How things have changed…One of my degrees is in Fashion Design, and I really believed that LULU had superior fit and superior quality. Price mattered little (after all, I'm a woman!). As someone who prefers to spend her time in the gym, I am overly specific about what I will wear. My sports bras must have support and coverage. My capris must feel snug, hide flaws, and be of breathable fabric. Second to this, I look for cut and style (something sexy, please), a variety of colors, and a few different style options. If it also happens to be the


Jamie's analysis dovetailed nicely with my own. Long ago, I hypothesized that LULU's grassroots marketing approach would eventually hit a wall. When it did, my suspicion was that the company's sales and marketing costs would increase dramatically as a percent of sales. As a result, its perceived advantage in the marketplace would dissipate, much to the chagrin of shareholders.

Technically speaking, LULU's financials have not borne that out. However, indirectly, they have. SG&A for the fiscal year ended January 29, 2012 amounted to 28% of total revenue (which was almost exactly $1 billion). This percentage has remained steady in the two years since. This demonstrates no benefit for having grown its revenue by 59% over that time frame.

Meanwhile, gross margins have declined from 57% in fiscal 2012 to 53% in fiscal 2014. Basically, Lulu has become less efficient organization as it has gotten larger. Without that higher SG&A I predicted, margins have been forced to suffer.

Annual Period Ending 2-Feb-14 3-Feb-13 29-Jan-12
Total Revenue 1,591,188 1,370,358 1,000,839
Gross Profit 840,076 762,826 569,351
Gross Margins 53% 56% 57%
Selling General and Administrative 448,718 386,387 282,393
SG&A % 28% 28% 28%

Source: PTT Research

Thus, it should come as no surprise that analyst estimates for the current and next fiscal years have been declining. Estimates for the year ending January 2015 have recently fallen from $2.20 to $1.89 (a figure that will obviously move further down after yesterday's debacle). The same goes for next year's estimate of $2.24, which has declined markedly over the past 90 days from $2.57.

To investors looking at Lululemon today, we have one rule of thumb to consider: "The trend is your friend". This is especially true in fashion. Barring an acquisition (which I view as unlikely given the 27% stake held by its founder, Chip Wilson), chasing value in this name holds more risk of leading one into a value trap than the potential reward offers.

In other words, for traders, the stock may be oversold at the moment, but the secular trend (down) is firmly in place. Until the company finds a way to re-endear itself to its core customer (women), I don't see how this can change, especially in today's draconian retail environment.

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. The author has no business relationship with any company whose stock is mentioned in this article.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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