Shares of Lululemon Athletica Inc. (LULU) stock, down 6.5% in 2015 through Tuesday’s close, cratered another 10% in midday trading on Wednesday, after fiscal third quarter results painted a picture of a retailer in trouble.
LULU, famous for its yoga pants, missed the mark on revenue and reported slumping earnings per share as a rise in inventories and a troubling slump in margins raised investor concerns.
Increasing competition from the likes of Nike (NKE) and Under Armour (UA) in the “athleisure” market should also have LULU stock owners on edge.
Lululemon also decreased its full-year 2015 revenue outlook to the range of $2.025 billion to $2.04 billion, when the previous peak of its revenue projections called for sales of $2.055 billion.
While there were a few positive figures that emerged from Lululemon’s report, most of them weren’t anything to brag about. It’s very possible that LULU stock might continue to underperform well into the foreseeable future.
Falling Earnings, Margins
But before focusing on the grim aspects of LULU stock, let’s touch on the good: Revenue rose 14% year-over-year, driven by an expansion in the number of retail locations and increase in same-store sales.
LULU had 354 stores open at the end of the third quarter, up more than 22% from the 289 it had at the end of the same quarter last year. And with same-store sales rising 6%, revenue growth was pretty much inevitable.
So why, then, did diluted earnings per share fall nearly 10% year-over-year, slumping from 42 cents per share to 38 cents?
There are a number of factors to blame, but the most worrisome for LULU stock owners is the slump in margins, which points to decreasing pricing power. Gross margins fell from 50.3% to 46.9%, while profit margins slumped from 19.4% to 14.2% year-over-year.
Elevated inventory levels are largely to blame, as selling through that inventory often requires retailers to discount their products. Unfortunately, LULU could be suffering from this problem for a while, and may be forced to sell spring and summer products alongside fall and winter inventory.
Zooming out and looking at the prospects of LULU stock in the long-term, a few glaring risk factors arise. The biggest question is whether Lululemon can continue to price its products at a premium in an industry that becomes more and more crowded everyday. The answer, at least according to the most recent results, is “no.”
With apparel giants Under Armour and Nike entering the market and inventory problems persisting, I don’t see an end to this problem.
After all, one part of the LULU website is titled “We made too much,” which, needless to say, reeks of desperation. The subhead shamelessly kneels and begs for business: “We made a little extra product, want to take it off our hands?” Below you find a list of deeply discounted products, including one pair of purple yoga pants, once $128, retailing for a mere $39.
And while I’m willing to concede the possibility that yoga is more than just a fad, it still could be a temporary craze, in which case LULU has done little to diversify its business or re-position its brand. As an investor, that’s a company I don’t want anything to do with.
As of this writing, John Divine did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @divinebizkid or email him at editor@investorplace.com.
