Lululemon's Gross Margins Are Its Biggest Problem; Bernstein Downgrades Stock

Analyst Anne-Charlotte Windal explained that the positive view on the company “as a small, under-penetrated and differentiated player in the athletic wear market, with substantial opportunity to drive topline,” remained unchanged.

In addition, the brand’s growth potential was reaffirmed by the 9 percent comp reported for 3Q15, which suggested robust momentum across the company’s different segments. Topline growth was still expected in the teens.

Related Link: Wedbush Cuts Target On Lululemon

A Look Ahead

Windal also believes that the decline in gross margin, seen over the past three years, can be partly corrected. “However, 3Q15 brought a number of concerning data points, which make it difficult for us to remain constructive on the name in the near term,” Windal stated.

Firstly, there has been no improvement in the company’s inventory levels, which were up 56 percent year-on-year in 3Q15. Management has guided to similarly high inventory levels for 4Q15.

According to the Bernstein report, “With elevated inventory level in an uncertain retail environment, level of markdowns in the next two quarters will be a moving target [...]If LULU were to experience below-plan comps for the quarter and had to aggressively work through an inventory glut by increasing markdowns, it could erode its price integrity.”