Lululemon Recapturing Customers; Other Issues Persist

In a report issued Thursday, Credit Suisse analysts Christian Buss and Sara Shuler looked into Lululemon after it reported a “low quality beat and modestly raised guidance as comp acceleration was offset by the company's continued struggle with product flow, which pressured margins more than expected.”

The Figures

• Gross Margins: Gross margins continued to deteriorate, falling 370bp year-over-year. This marks a reversal from the previous quarter, and signals “supply chain challenges and higher occupancy burden.”
• Inventory Growth: Inventory growth of 59 percent was considerably ahead of guidance for third-quarter sales growth, which called for 14 to 15 percent. The inventory-sales gap stands at one of its highest points ever.
• Rev And Comps: Revenue and comps accelerated over the quarter. This suggests that the new product design team is managing to recapture lost customers and to attract new ones. Over time, this should help recover store productivity and, consequently, operating margins.
• SG&A Expense: SG&A expense was highly disciplined. The analysts think “the weak Canadian dollar likely supported SG&A translation as the bulk of back office and support services are located and paid for in Canadian dollars.”

“Ultimately, an acceleration of full year comps to the high single digits from mid to high is not going to translate into material earnings upside or earnings growth,” the experts assured. Longer term, these problems raise questions around Lululemon’s ability to return to 20 percent (or more) EBIT margins and its overall earnings growth potential. Thus, the company's 30x forward P/E multiple carries considerable risk.

Credit Suisse maintains a Neutral rating and $57.00 target price on the stock.