Lululemon Athletica Inc. (LULU.O), maker of yoga clothing, was knocked down to the mat in 2013, with an embarrassing recall of see-through pants and turbulence in the executive suite. With its fiscal year ending on Feb. 2, 2014, we look at how much muscle is in Lululemon’s financial outlook.
Click here to watch Jharonne Martis’ corresponding interview on Reuters Insider
StarMine shows that LULU’s current earnings per share mean estimate is 73 cents and every analyst covering the stock has lowered EPS projections. On the StarMine Valuation-Momentium (Val-Mo) Model, LULU scores a very weak 1, which combines two sets of metrics designed to measure a stock’s merits from both a value and growth perspective.
The stock’s price momentum also looks bad, with a Price Mo score of 1 and weak medium momentum as well as industry momentum. As a group, U.S. Textiles & Apparel stocks are down by 2.3% over 30 days. LULU’s current forward 12-month P/E ratio stands at 21.5, compared to the median five-year value of 33.1.There’s some potentially good news — earnings are expected to grow this year by 2.7% to $1.90, according to our mean estimate. But after that, watch out. StarMine calculates that the market is pricing LULU’s shares as if the company will generate 12.36% compound annual earnings growth over the next five years. Looking at the StarMine Intrinsic Value model, we see that LULU would need 8.9% compound growth for the next 5 years to be fairly valued at $34.17 vs. the market’s $47.62.
EXHIBIT 1. LULULEMON EARNINGS PER SHARE EST VS. ACTUALS: 2012 – 2013
Source: I/B/E/S
Critical moment for LULU
As the company continues to recover from the translucent yoga pants recall, it has also lowered its earnings and sales projections for the fourth quarter. As a result, it is seeing its share price decline. Analysts believe that the decline in sales is related to the bad weather seen in early January that kept shoppers at home. The “polar vortex” also hurt Lululemon’s distribution, which is critical for the company since it only offers a limited number of items. The new guidance also indicated that weak store traffic is expected throughout the remainder of the month/quarter.
At this week’s ICR conference, CFO John Currie said, “The quality problems that we had earlier in the year were a real wake-up call. Since then and even prior to that we’re on a path to implementing what will become best-in-class quality assurance at Lululemon” (Source: Lululemon, 1/14/2014). This is key for the company as an increasing number of customers seem very upset in their reviews on its website, criticizing product quality and what they see as poor value. As a result, most of the company’s reviews have very low customer ratings – about three out of five stars.
Competitive strength from Athleta
Lululemon has also seen increased competition from Gap’s (GPS.N) Athleta division. The latter offers similar merchandise at slightly lower price points. What’s more, Athleta’s customer reviews show that its customers are very pleased with pricing and product quality. One recent client wrote on Athleta’s site, “these are worth the price and great for casual wear as well as excellent for yoga. They do not bother my sensitive skin, and they feel wonderful with boots! Glad I took the plunge” (Source: Athleta’s site, 1/14/14). Athleta product reviews are stronger than Lululemon’s – about 4.5 out of five stars.
Athleta also has invested in research and development to improve the aesthetics of some of its yoga pants. Lululemon is also considered a fashion statement. Women wear their gear for shopping and meeting friends, and Athleta is trying to replicate and improve their pants towards a more casual look.
Who’s the leader?
Please click to view the infographic
Despite the 2013 mishap, StarMine analysts still believe LULU is the leader in this market. During this past holiday season, Lululemon implemented in-store mobile e-commerce capability that allowed customers to make an order in-store and have it delivered to their house within days. The retailer plans to expand this strategy to its other stores by the second half of 2014.
Athleta’s parent company, Gap, is an established business with the necessary resources to expand and grow Athleta’s market share. The retailer plans to expand its locations to over 100 locations in 2014. Analysts believe Athleta has gained market share during Lululemon’s fiasco. Athleta is also known for opening stores in the vicinity of Lululemon, making it easier to steal some of Lululemon’s core consumer — especially when offering lower prices. This is key right now, since the value proposition is currently so important to the U.S. consumer.
However, Lululemon has a stronger brand name, and loyal customer base – which has helped Lululemon through the difficult times.
Key points: quality control and leadership
Going forward, quality control is a top priority for Lululemon, but will it translate into continued sales and customer loyalty?
Improved leadership is also a must in order to regain investor sentiment and long-term growth potential. Lululemon’s stock price suffered during its CEO search. The retailer’s value is just as dependent on its product, leadership and yoga culture. Laurent Potdevin, who took over last December, had 25 years of experience at Burton, showing that he can manage a successful activewear brand. His experience at Toms shoes shows he has worked with a brand where quality, culture and social awareness are important. Since Lululemon targets affluent women, Potdevin’s experience at LVMH is a plus.
The LULU culture
Culture is very important to LULU – more than the product itself, the company has succeeded in creating a lifestyle and a community that embraces it. This in return has created brand loyalty and is what also maintains LULU as the leader in the industry. Athleta is already replicating this model. They offer fitness classes at various locations. Athleta also offers free hemming on pants, skirts and dresses.
In addition, Athleta General Manager Nancy Green has been with Gap for 27 years and was pivotal in Old Navy’s turnaround and Gap’s China business, which is perfect for a growing brand like Athleta.
Yogawear as an industry has become so attractive that celebrities are even jumping on the bandwagon. Russell Simmons has announced that he will launch a yoga brand called Tantris. The brand Sweaty Betty, out of the U.K., is now taking its first step into the U.S. market with its first announced retail location.
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