Lululemon Earnings Disappoints… Time To Sell LULU?

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Lululemon Athletica (symbol: LULU) is well-known for its yoga apparel. The company prospers due to  an increasing number of health-conscious women, so-called “yoga-moms” and saw its sales increasing with 80% during the past three years. Sales did however suffer from a big recall of yoga pants that appeared to be see through in 2013. Fast forward to today, the company reported Q3-earnings which were below market expectations, sending its share price sharply down. Has the growth story ended and is it now time to sell?

Lululemon operates in a somewhat niche. Although other sport apparel companies also produce sportswear suitable for yoga, the Vancouver -based company is one of the few who offer a product range perfectly fitted for yoga. Its tradition of a combination of style and performance appeals to a large number of females. However, this is also a risk for the company. Contrary to men, women are much less brand centric and switch easily to other brands. Competition is increasing, for instance from other sport brands such as Nike and Under Armour, but also designer-brand Tory Burch offers yoga wear since early 2014.

During Q3-2015, Lululemon was able to increase its revenues with 9% to USD 480 million, which missed expectations of USD 482.3 million slightly. It topped analysts’ estimates with one cent by reporting an EPS of USD 0.38. Nevertheless, compared to last year this is a decline. Net income fell this year to USD 53.2 million from USD 60.5 million last year.

The problem is that the company disappointed with its guidance for the next quarter and for whole 2015. Lululemon expects Q4-revenues to come in the range of USD 670-685 million, which is below a consensus of USD 690.9 million. It lowered the guidance for full 2015 sales from USD 2.025-2.055 billion to USD 2.025-2.04 billion. Market expectations stood at USD 2.058 billion. Moreover, EPS guidance was lowered to USD 1.81-1.84 (from USD 1.87-1.92) where analysts are looking for USD 1.91. But the main concern was the lower operating margin of 14.2%. Lululemon’s long term plan is a range of 20-25% and this looks quite optimistic in the current environment.

The company is looking for expansion outside of North America. By 2017, there should be 40 stores in Europe and Asia. For now, the brand reception was quite strong. Lululemon’s Hong Kong store is on track to be the most productive. Nevertheless, international expansion will likely come at the cost of operating margin. Despite being a strong name in the US, it’s relatively unknown in the rest of the world and that requires marketing.

Shareholders seem to anticipate lower margins and slower revenue growth than in the past. Lululemon’s shares are valued at a P/E-ratio of 24 and P/S stands at 3. That seems lofty, but compared to its peers it is more or less in line or even cheaper. Nike is trading at a P/E of 30 and a P/S of 3.4. However, Nike is a much more diversified brand name and is probably less sensitive to consumer preferences (as noted earlier). Lululemon is a clear underperformer with its shares down 17.5% for the year, compared to a plus of 35% for Nike or 25% for Under Armour.

Investors will closely monitor Lululemon’s ability to continue historical growth and will watch international expansion. It is important not to sacrifice margins. Therefore, an investment may come down to trust in the brand’s collection and whether it can continue to match consumer preferences. Hopefully product recalls won’t spoil that.

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