LULU Loses Its CEO As Stock Skids: What Now?

Lululemon Atletica LULU reported first quarter results that beat analyst estimates Monday after the close. The company also guided higher than analyst expectations for the second quarter although a string of negative announcements accompanying the release weighed on shares.

First Quarter Not So Sheer

Despite the sheer pants scandal in the quarter, Lululemon reported first quarter earnings per share of $0.32 vs. $0.30 expected on revenue of $$345.8 million vs. $341.0 million expected. Also, the forecasted sales for the second quarter between $340.0 million and $345.0 million, better than the $328.88 million estimate, and forecasted full year sales of between $1.65 billion and $1.67 billion vs. the $1.64 billion estimate.

The company noted that the scandal over the pants that were too sheer had only a marginal effect. Lululemon expects no long-term damage to its brand from the mistake, a key piece of guidance moving forwards.

Corporate Actions Weigh

With the strong earnings, revenue, and guidance, shares would be expected to be up, not down 16.5 percent. Well, Lululemon had other problems that made this company look just like a lemon.

One announcement the company made was that CEO Christie Day is unexpectedly retiring from the company. She said that she will pick her predecessor for the Board to approve, someone who stands be her 10-year plan for the company. However, the unexpected nature of the move coupled with her association to the company during its mega-growth phase has raised concerns that without her, the company can't continue.

Another announcement the company made was that it was to de-list its Canadian traded shares. This move also came as a shock as Lululemon and leaves the company with U.S. listed shares only.

Analysts Weigh In

Analysts at Goldman Sachs noted the slowing sales growth rate as a key negative for the stock in the release. "Aging is natural and can occurr in a graceful manner, but the slower embedded growth rate could lead to a re-rate lower from LULU's 35- 40X P/E range. "

"Supply chain investments could be a drag on margins and temper medium-term profit growth. These include areas like quality control and logistics. We see some execution risk as the unexpected leadership departure comes at a time when we believe strong leadership is needed to guide LULU through this life-cycle transition."

"We see the risk that slowing growth drives a negative re-rate towards 20-25X P/E (consistent with later stage growth names), from the current 35-40X range. Our new $60 6-month price target (from $72) reflects 25X, from 30X prior." They maintained a neutral rating on the stock.

Credit Suisse's analysts voiced similar concerns. "We view the departure of Christine Day as a clear negative for lululemon. In our view, Christine has been a key architect of the company's success, and we see her experience as President of the Asia Pacific Group of Starbucks Coffee as a key advantage as the company makes early forays into international markets (showrooms open in Berlin, London, Singapore, Hong Kong.) We note that lululemon has lost three executives over the prior 18 months Christine Day (June 2013), Sheree Waterson (April 2013), and Chip Wilson (January 2012.)"

"Following 1Q13 results, our FY13 comp, revenue and EPS estimates go to 9.3%, $1,693.8M, and $1.98 from 5.3%, $1,639.8M, and $1.97. Our FY14 estimates go to 11.1%, $2,125.2M and $2.65 from 14.2%, $2,126.0M and $2.71. We are lowering our target price to $73 from $75 (27.5x FY14E)." They also rate the stock at a neutral.

Why So Serious?

Some disagreed about the news, seeing the departure of Ms. Day as not so bad. Morgan Stanley voiced this opinion, saying that all that has changed is the CEO. "CEO Christine Day's resignation raises concerning questions, but LULU's EPS story did not change. Our FY13 EPS estimate remains $2.03. The stock is a compelling growth story but probably fairly valued even after the mgmt switch gets priced in." They maintained an equal-weight on the stock.

Canacord Genuity analysts remain bullish despite the news and maintained a buy rating. "We are fans of Ms. Day's as she was instrumental in building the LULU brand to where it is today. While details are scant, we have to believe her departure was prompted by the recent product quality issues. As such, the lack of visibility in key leadership roles (CEO, designer, supply chain) heightens the near-term uncertainty, likely leading to multiple compression."

"At this time, we have no reason to believe the fundamental growth trajectory of the business or consumers' desire for the brand has changed, but recognize the risk profile is greater today. Moreover, we suspect less tolerance will be allowed for future stumbles until a successor is named. In our opinion, LULU remains a strong retail growth concept, but we are lowering our P/E multiple to 30x (~1x PEG) from 35x, resulting in our price target reduction to $87 from $92."

Cloudy Future

The common theme amongst analysts Tuesday was that the underlying company appears to be performing as expected and where it should be given its age and growth profile. However, the increased uncertainty due to executive departures coupled with the fact that Ms. Day was the company's leading expert on expanding into Asia as it pushes sales into that region raises more questions than the quarter's performance answers.

Stern Agee agrees. "We are downgrading LULU from Buy to Neutral following the announcement of CEO Christine Day's resignation. We believe that the cultural cohesiveness that Ms. Day brought to LULU will be very difficult to replace. We are comfortable that Ms. Day, as she said, will remain at the helm and fully engaged until her replacement is comfortably in place. Nonetheless, the change in leadership is disruptive."

"On top of Ms. Day's pending departure is the need for three key positions within the organization to be filled: the SVPs of Product Design & Merchandise, of Logistics, and of Product and Supply Chain. Despite the fact that we are raising estimates and believe that 2013 guidance will prove conservative, the lack of information regarding the future leadership of LULU is of great concern. We are lowering our PT from $90 to $75, a PE of 37X and 27X our revised '13 and '14 estimates. We anticipate compression of the out- year multiple of 30X."

Omar Saad, analyst at ISI Group, was left "dazed and confused" on the news. "Last night's announcement of CEO Christine Day's sudden departure stunned us, and unfortunately the conference call left us with more questions than answers. Perhaps this is simply a story of a Board and CEO amicably parting ways, but we don't have answers to these puzzling questions, which in our opinion makes it difficult to know what to do with the stock without greater insight."

"We still unequivocally believe that Lululemon is a unique brand that successfully combines style, performance, and a retail shopping experience that is unparalleled, and hope that the Board will be able to find another leader with both premium brand and global consumer experience to replace Ms. Day. In the meantime, expect the stock to be range-bound as we all wait for further light to be shed on this situation."

Margins in Focus

Several of the analysts noted future margin compression as another worrisome sign, a headline that slipped through the markets. "New black luon pants having been trickling back into stores for three weeks, and the company will be fully in stock in black luon by the end of 2Q," wrote Bank of America. "We are modeling GM to decline 230bp y/y in F2013E to 53.4% to reflect inventory write downs, additional markdowns and additional QA costs."

"Our US$60 price objective is based on a 25x 2014E P/E. This P/E is above peers, due to what we believe are lulu's best-in-class growth prospects, which include a productive US rollout, rapid e-commerce growth, eventual international expansion and a development concept." Bank of America maintained an underperform rating on the stock and warned that further operational slowdowns or a slowdown in consumer spending are risks to the stock here.

No Consensus

With shares down 16.5 percent Tuesday, there is no consensus on the stock. Some remain bullish here while others are skeptical. 50 percent of analysts are neutral on the stock while 35 percent are bullish and 15 percent have sell ratings. Basically, the next move is anyone's guess.

Technically, the Relative Strength Index is indicating that the stock is oversold at current levels on multiple time frames. The RSI on the daily chart points to a massive oversold situation while on the 15-minute chart, the stock is nearly in extreme oversold territory. Interestingly, volume is way above average today as over 24 million shares have traded when just about 2 million trade in a day on average.

The best thing for the company now is for the new CEO to be announced as soon as possible. However, until then, expect that shares remain depressed until some of the uncertainty weighing on the stock settles out.