Lululemon (LULU) reported better-than-expected second-quarter earnings before the bell Thursday. That’s great news for LULU stock holders, who have eaten 35% losses so far in 2014.
LULU stock sits more than 50% off its all-time highs — set just hours before former CEO Christine Day announced she was stepping down — but it finally appears ready to end its downward spiral. Like most difficult undertakings, Laurent Potdevin’s turnaround plan isn’t exactly happening as quickly as everyone would like, but at least LULU can see the light at the end of the tunnel.
In June, I recommended investors bu LULU stock. Nothing in today’s earnings report (nor after today’s 15% pop) changes that.
The Lowdown on LULU Earnings
Lululemon earnings of 29 cents per share were down 15% year-over-year, but beat expectations by 4 cents. Lululemon has now surprised to the upside in each of the last five quarters.
In June, Lululemon said EPS for fiscal 2014 could be $1.76 at the high end of guidance, 14 cents lower than just three months earlier in March. This quarter it has upped its 2014 EPS outlook by 1 cent at the top end of guidance (to $1.77), putting some bounce back in LULU stock and a brighter light on Q3 and beyond.
Same-Store Sales
In Q2, total comparable sales were flat amid a same-store sales decline of 5% on a constant dollar basis. Helping rein in the overall decline was its direct-to-consumer business, which grew at a 30% clip and now represents 16.2% of its overall revenue, 190 basis points higher year-over-year. For all of 2014, Lululemon expects low-single-digit total comparable sales, which means same-store sales should be flat to slightly negative, while its online business should see strong double-digit growth.
But forget these numbers. They’re meaningless in a turnaround.
Potdevin is likely more concerned about getting Lululemon’s style back and broadening its appeal. Nomura analyst Robert Drbul suggested in a note to clients that Lululemon’s &go streetwear line “appears to be gaining traction.” Getting the product mix right will naturally take care of same-store sales growth.
High margins combined with scarcity of product makes for a winning combination.
Don’t get me wrong, one of Lululemon’s problems has been too much of the crappy stuff and not enough of the good, expensive stuff. Laurent Potdevin wants to remedy this. However, I wouldn’t expect positive comps until early in fiscal 2015.
Lululemon and the Competition
At this point, Lululemon’s biggest concern is the competition. I can count four firms with superior resources than Lululemon: Nike (NKE), Under Armour (UA), VF Corp. (VFC) and Gap (GPS). Combined they have an average market cap of $34 billion, more than five times LULU. With Gap pushing hard on its Athleta stores, VF Corp. expanding its Lucy stores and both Under Armour and Nike bringing new products to market, Lululemon has to bring its A-game in the coming quarters.
Unlike most startups, LULU’s easiest time was probably when it opened its first store in Vancouver in 2000. Today, the “athleisure” market is growing by leaps and bounds and is projected to be as large as $100 billion by 2020.
Lululemon’s Q2 report at least suggests it’s ready for a fight.
How’s the Supply Chain and Merchandising?
From a supply perspective, things are actually pretty good.
RBC Capital Markets analysts Howard Tubin and Courtney Wilson believe LULU is “reaching the inflection point.” The duo see a lot of good things happening with LULU including better products, better processes and generally a better flow of product into the stores.
Relatively new product chief Tara Poseley is expected to add a lot of design awareness to the LULU team. Her recent work doesn’t illicit much excitement (she was head of design at Kmart) but Poseley spent 15 years at GPS, leaving in 2004. You don’t think she wants to show up her former long-time employer? This aspect of the competition makes the future very compelling for LULU stock.
Potdevin has brought in some high-priced talent to fix the supply chain and merchandising. Long-term, I’m confident he’ll get the fixes in place.
Whether it’s enough to beat the big boys is another question altogether.
Chip Wilson and Advent International
The best thing the LULU founder did for shareholders, including himself, was to sell half his 28% interest for $845 million to Advent International, the same private equity dudes who bought 48% of Wilson’s baby back in 2005 for $93 million and who were responsible for the hiring of Christine Day back in 2008. Although I didn’t always agree with Day’s approach, she certainly was good for LULU stock.
This move brings stability back to the boardroom, and that’s a good thing.
Expansion
Laurent Potdevin stated in Lululemon’s Q2 earnings release, “We are pleased to be on track with the implementation of our strategic road map, and are starting to see the results of our work across product, brand and international expansion.”
Those final couple words are critical to Lululemon’s future.
Over the next 18 months, the company is building the infrastructure necessary to support business outside North America in Europe and Asia. In the earnings conference call, Potdevin suggested Lululemon would have 20 stores in both regions by 2017.
In Q2 its men’s business grew comps by 5% (stated in conference call) following 9% year-over-year growth in the first quarter. This segment generates approximately $216 million in annual revenue and accounts for more than 13% of Lululemon’s overall business. Its men’s business is definitely one of its growth areas, with the first standalone store expected later this year in New York City.
The third piece of Lululemon’s plan for growth involves Ivivva, its activewear brand geared to girls 4 to 14. Opening stores and showrooms across North America, it now has 18 stores open with an equal number in both Canada and the United States. Generating close to $1,000 per square foot (revealed in conference call), the Ivivva brand allows Lululemon to acquire customers at an early age building stronger brand loyalty which ultimately will help LULU stock in the form of increased revenues.
Bottom Line
CFO John Currie stated in the earnings conference call that Lululemon expects to return gross margins to the mid-50s (currently in the low 50s), where they’ve been historically as it improves efficiencies across its entire supply chain. Adding a distribution center in Columbus, Ohio, is just one example of how Lululemon is improving its supply chain which ultimately will lead to a healthier bottom line.
I thought Laurent Potdevin was the right guy for the job when he was hired at the end of 2013; everything that has happened in 2014 suggests I wasn’t wrong.
Another couple of feel-good quarters, and I wouldn’t be surprised to see LULU stock trading at $60 or more.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.