Lululemon Athletica Inc. (LULU) is a designer, manufacturer and retailer of yoga-inspired apparel. Since its creation in 2002, the company has grown from a single store to over 250 locations in the US, Canada and Europe. Its original target market is women in their 30s, but the brand has broadly expanded to new categories including women of all ages, men, youth and focused fitness wear. Its designs have performance features and are made with technology enhanced fabrics. The high quality of its products has positioned the company as a premium brand that caters to affluent consumers.
Its marketing strategy has allowed Lululemon to attain great brand loyalty. The firm distributes its products through yoga studios and top fitness clubs and is also affiliated with yoga and fitness instructors. Thus, the company has developed great connection with its customers. This approach and the company´s adaptability to new market needs have proved right, since annual sales have risen almost six-fold since 2007.
Quality Issues and Powerful Competition
Despite its strengths, Lululemon suffered tough quality issues over the last quarters. Its heaviest misstep was the sheerness of its popular luon fabric. This defect resulted in the company´s pulling out from the market all of its luon-made items, which represent around 17% of all yoga pants. As a result, there was a shortage of these products during the first quarters, which had a significant impact on comps. The fourth quarter also showed a decline in sales with comparative same-store sales expected to be in the low-to-mid single digits. Such results hadn´t been seen since the recession, when the company reported negative comps on the first two quarters of 2009.
Moreover, an unusual January saw traffic and sales trends slow down significantly, partly due to two Polar Vortexes hitting the middle and east coasts of U.S. and Canada. Consequently, the company suffered a cut in its fourth quarter estimates and earnings per share guidance was lowered to $0.71-$0.73 from $0.78-$0.80. Nevertheless, analysts’ forecast for fiscal 2014 still sees a rebound in earnings growth which is expected to raise by 17.3%.
Another factor threatening to erode Lululemon´s margins is growing competition from strong companies such as GAP (GPS), Under Armour Inc. (UA) and Nike (NKE). The hole opened by the company´s inventory shortage, and the damage the luon incident caused to the brand image, was well addressed by its rivals. In this manner, UA started producing yogawear apparel and recently launched its studio yoga wear ad campaign. Following this line, GPS opened several Athleta yogawear outlets near Lululemon locations and has partnered with yoga instructors to offer fitness classes. And , NKE is also targeting high to the women´s yoga apparel segment.
Balance Sheet and Valuation
In spite of all headwinds, Lululemon is still a fast growing and profitable company. Its balance sheet shows no debt and it has strong free cash flow, which the company is redirecting to investments in order to expand its operations to new categories. As long as the firm avoids future product missteps, the success in its new initiatives and its strong brand identity can provide Lululemon with a narrow economic moat.
A super high return on equity of 30.50 compared to the 9.0 industry median goes along with an outstanding return on capital of 135.3 relative to the 19.1 industry average. Its revenues grew 43.4 compared to rivals’ average of 7.0, and earnings per share soared to 65.20, leaving the rest of the industry look weak at 13.50. Lulemon´s stocks trade at 23.40 its trailing earnings compared to 18.20 held by the industry median. Analysts’ estimates forecast a growth of 16.9% and for the next five years, the company’s earnings per share are expected to grow an impressive 18.4% per year. Rivals Gap and Nike on the other hand expected an increase of 13.5% and 12.3% respectively in their EPS. Therefore, although investment guru Steve Mandel (Trades, Portfolio) recently sold out, I feel strongly bullish about the Lululemon´s growth potential.
Disclosure: Vanina Egea holds no position in any stock mentioned.