Lululemon Athletica (NASDAQ: LULU) had a rocky 2013, with a wide range of problems including product recalls, brand image problems, a CEO that put his foot in his mouth that all led to disappointing results. The stock is down over 20% in the past 52 weeks, compared to the S&P that is up over 25% during the same period. The underperformance is dramatic but is all the negative news priced in or will Lulu’s problems continue to mount in 2014 leading to further share underperformance.
Lululemon’s 2013 Troubles
In 2013, Lululemon had to recall its signature luon pant that constitute 17% of total company sales. Consumers complained the pants were partially see through. There was an immediate impact on sales of $67 million versus the company’s current TTM sales is $1.56 billion. However, the damage to the brand was and is ongoing.
Lululemon had established itself as a brand that sold only the highest quality products. Consumers started to make noise that between this and a pilling issue on yoga pants, quality was slipping at Lulu. Customers expected quality and see through pants and fabric that deteriorates quickly is not acceptable when paying over $100 per pair.
Then to top off a product quality issue, Chip Wilson, the company’s founder, made some controversial statements in the press to alienate more consumers. He commented “some women’s bodies just actually don’t work” in Lulu’s pants. Needless to say, suggesting that the quality issues were not related to fabric problems and Lulu’s manufacturing practices, but to the buyer’s body types, did not go over very well.
Management and Board Shake Up
It was announced on December 10, 2013 that Chip Wilson would resign as Chairman of Lululemon and be replaced by current board member Michael Casey in 2014. Wilson will still serve on the Board.
In a bigger surprise, Laurent Potdevin will take over as CEO from Christine Day this month. She resigned citing personal reasons. The addition of Potdevin, who was serving as President of Toms shoes and was formerly the CEO of Burton Snow, was viewed positively by analysts including Liz Dunn of Macquarie. She stated, “Our initial reaction is that this is a great hire.” Lulu also added Tara Poseley as Chief Product Officer who comes from Kmart.
Lulu may have needed a change in management, as the previous team had numerous situations arise in 2013 that were not properly managed, but Day will be missed. During her five year tenure, sales and the stock price soared.
In 3Q13 (ended Nov 3, 2013), the company reported sales increased by 20% y/y with comparable same store sales up 5% on a constant dollar basis. There was a shift towards online with direct to consumer sales up by 36% in 3Q, and accounting for 16.3% of total sales versus 14.3% in 3Q12. EPS was $0.45 in 3Q13, up by $0.06 from the same period in the prior year and above $0.41 consensus. Guidance was disappointing and was reduced from prior levels based on a flat 4Q comp coming from softer traffic trends, very competitive retail environment, and product delays from the reorganization of the supply chain.
Upside Story – Overseas Growth, Image Headwinds Subside
Expanding into overseas markets and becoming a global brand is the next growth challenge for Lululemon and its management team. Macro global growth forecasts expect consumer discretionary to lead the way in 2014 and 2015, much the way it did in the US in 2013. Lulu can position itself to take advantage of this and a trend toward luxury goods in many markets. It represents substantial long-term upside and can offset lower US growth rates.
Second, the company is working to improve the brand image following the debacles in 2013. This remains a headwind and it remains uncertain how damaging it will be to long-term sales. However, the impact should subside at least somewhat as time passes. Better product quality and distancing itself from Mr. Wilson should help.
Downside Concerns – Brand Does Not Rebound, Competition and Further Product Sourcing Issues
Lulu remains an at risk stock even after a poor performance in 2013. The brand still has image problems and they may have come at the wrong time. Brands like Nike (NYSE:NKE) and Under Armor (NYSE:UA) have improved their product lines to more directly competes with Lulu’s. Both would likely have gained some market share but may take more than expected following the Lulu’s issues. Changing its image in the US could prove to take longer and lead to same store sales disappointments.
In addition, Lulu continues to have product delays and sourcing problems. It made changes last year following the issue with its pants. The new suppliers and production have acted as a headwind since and could continue to in 2014. That said, guidance and then analysts’ forecasts were dialed back following the recent earnings report.
Lulu is likely in the middle to late innings of dealing with its issues that started in 2013. The Street has baked most of these issues into the current share price and moving past them in the next few quarters could represent upside. In addition, creating a larger global sales footprint represent the biggest growth channel for Lulu and can drive the stock for the next few years.
What are your thoughts on the future of Lululemon? I know my wife has never shopped there, and finds better value for good quality at stores like Target.
John has seven years of experience as an equity analyst following various stocks and sectors. As a senior equity analyst, he received awards from the Wall Street Journal and Financial Times for his writing.