Lululemon Down to Strong Sell - Analyst Blog

On Apr 1, 2014, Zacks Investment Research downgraded Lululemon Athletica Inc. LULU to a Zacks Rank #5 (Strong Sell) following a not-so-convincing outlook for the first quarter and fiscal 2014 provided at the fourth-quarter conference call last week.

Why the Downgrade?

On Mar 27, Lululemon announced its fourth-quarter fiscal 2013 earnings results. Although fourth-quarter earnings of 75 cents exceeded the guidance range of 71 to 73 cents, we want to remind investors that the range was determined after the company slashed its forecast twice in a 2 month-span.

The company had first lowered its fourth quarter guidance during its third quarter conference call due to soft results and consequently trimmed its forecast in January citing a tremendous fall in customer traffic and sales trends since the start of January.

Moreover, gross margin contracted 300 basis points (bps) to 53.5% compared to the prior-year quarter, primarily due to a substantial fall in the product margin due to a mix shift to seasonal low margin products, elevated air freight usage, higher inventory reserves, increased foreign exchange translation due to weaker Canadian and Australian dollar and an increase in fixed costs, namely occupancy and depreciation costs as well as product and supply chain costs.

The company's results were further hurt by higher SG&A expenses during the quarter, arising from increased in-store labor and operating expenses at new stores as well as increased variable costs for operating the online business and higher expenses at store support center stemming from salaries, administrative expenses and professional fees.

Though the tone of the company's conference call was positive as its management team gained confidence under the new CEO, the company's troubles with the Black Luon issue and the controversial comments from the founder will take time to fade from the minds of investors. Therefore, management has been cautious with its outlook for fiscal 2014 as it expects these headwinds to continue into 2014.

For fiscal 2014, Lululemon expects earnings in the range of $1.80–$1.90 per share, which is below $1.91 reported in fiscal 2013. For the first quarter, the company projects earnings in the range of 31-33 cents per share, which is in line with 32 cents reported in the prior-year quarter.

Moreover, the company expects gross margin to be pressured in fiscal 2014 anticipating it to be in the low 50s range. Further, the company projects SG&A expenses as a percentage of revenues to increase year over year due to investments in infrastructure to drive growth in areas such as brand, product innovation and guest experience as well as the difficult comparisons from the prior year, which included foreign exchange gains and reduced management incentive compensation.

Taking cue from the chain of events at Lululemon and the soft forecast for fiscal 2014, all the estimates were revised downward. The Zacks Consensus Estimate for first-quarter 2014 and fiscal 2014 slipped 20% to 32 cents per share and 14.6% to $1.87 per share, respectively, over the last 7 days. Similarly, estimates for fiscal 2015 fell 8.8% to $2.28 per share over the same time frame.

Other Stocks to Consider

Better-ranked stocks in the apparel retail space include Michael Kors Holdings Limited KORS, Hanesbrands Inc. HBI and American Apparel Inc. APP. Of these, Michael Kors holds a Zacks Rank #1 (Strong Buy) while Hanesbrands and American Apparel carry a Zacks Rank #2 (Buy).