Lululemon’s share price has tumbled nearly 40% this year, with investors spooked by slowing sales and a surprise C-suite shakeup in May. The departure of the Chief Product Officer and subsequent team restructuring fueled fears of deeper issues, sending the stock to a 52-week low of $293.
This sell-off highlights a common, if unfortunate, truth about the stock market: price action often drives the narrative, not necessarily the underlying business fundamentals.
When a stock soars, it’s crowned as the next big thing, and it can do no wrong. Investors become blind to potential risks.
But when the share price drops, suddenly all the previously overlooked risks stick out like a sore thumb. Investors scramble to justify the decline, conjuring up all sorts of reasons to explain the price movement, from heightened competition to a saturated market, regardless of whether these concerns were truly material before.
In Lululemon’s case, the whispers grew louder as the share price tumbled: “No one wears overpriced yoga pants anymore!”
Yet, the Q1 2024 earnings released on June 5th told a different story – an average one, quite frankly, but one that beat expectations nevertheless. Lululemon’s stock popped over 10% after hours. So, what gives? Were expensive yoga pants suddenly back in trend?
Well, it’s more nuanced than that. Let’s unpack the results.
International Markets Fuel Growth, While Domestic Sales Lag
Lululemon’s overall revenue grew by a healthy 10%, reaching $2.2 billion. The driving force? A stellar 35% surge in international sales, with China leading the pack at 26%. Clearly, Lululemon’s global ambitions are bearing fruit.
However, the story back home in the Americas was less rosy, with a mere 3% growth. This slower pace can be attributed to several factors:
1. Missed Opportunities in Women’s and Bags:
Lululemon’s CEO, Calvin McDonald, admitted to some missteps in the women’s category, particularly with their core legging offerings. Limited color options and size availability early in the quarter, although rectified, still put a dent in sales.
McDonald explained, “In women’s, we came into the year with a missed opportunity across our size profile, particularly our smaller sizes. We are now back in stock in all sizes, but we are still seeing an impact on productivity in our key bottoms franchises due to the lack of color in our core styles. While we have newness flowing in now, we didn’t start the quarter with enough color in our assortment, impacting our results.”
The company also experienced missed opportunities in the bags category, contributing to the overall slower growth in the Americas.
2. Macroeconomic Factors Impacting Sales:
The challenging macroeconomic environment, including high inflation and cautious consumer spending, also played a role in the slower growth. Calvin McDonald noted, “We know that the consumer environment remains dynamic with inflation and higher interest rates. So, it’s weighing on the mind of the consumer, and we also know they will spend, but they’re being selective.”
Profitability and Margin Analysis
Gross profit increased by 11% to $1.3 billion, with gross margins widening by 20 basis points to 57.7%. This gross margin expansion was primarily attributed to lower product costs, particularly due to decreased air freight expenses. As CFO Meghan Frank explained in the earnings call: “…lower product costs, lower airfreight costs, and lower inventory provisions.”
Operating profits increased 8% to $432.6 million, though the operating margin declined by 50 basis points to 19.6%. This was primarily due to the company’s strategic investments in growth initiatives:
1. Digital Marketing: Lululemon is actively investing in digital marketing to enhance its brand awareness, reach new customers, and drive online sales. This includes initiatives like targeted online advertising, social media campaigns, and content marketing. CFO Meghan Frank mentioned these investments as a key driver of higher SG&A expenses.
2. Technology: The company is investing in technology to improve its e-commerce platform, enhance customer experience, and streamline operations. This includes investments in areas like data analytics, personalization, and omnichannel capabilities.
Inventory Levels Coming Down
As noted in my previous Lululemon analysis, the company has been wrestling with excess inventory since the pandemic. Competitors facing similar challenges resorted to heavy discounting, providing short-term relief but potentially harming their branding in the long run.
In my prior analysis, I mentioned:
“However, a potential area of concern lies in Lululemon’s inventory management. The days inventory outstanding (DIO) has seen a rise from 96 days in the pre-COVID era to 126 days currently, indicating a slowdown in product turnover. This trend mirrors challenges faced by Nike and Adidas, who responded with heavy discounting to alleviate their inventory surplus. For Lululemon, the goal is to address this without resorting to such discounting strategies, which could undermine the brand’s premium positioning and value.”
This quarter’s results showed that Lululemon continues to avoid heavy discounting, as gross margins held up, and it’s good to see the inventory bloat coming down. CFO Meghan Frank explained:
“Our inventory levels were down 15% versus last year, which reflects our proactive approach to managing inventory in a dynamic environment. We are confident that our current inventory levels are appropriate to support our growth plans.”
There’s still a lot of work for Lululemon to do in managing their inventory levels, including resolving the shortage of its core leggings offerings, which is currently a bottleneck in the Americas operations. However, it’s promising to see the company prioritizing brand integrity and not resorting to heavy discounting to drive short-term sales and clear inventory.
Share Buybacks: A Strategic Move
In Q1 2024, Lululemon repurchased 0.8 million shares at a cost of $297 million, representing approximately 0.6% of the total shares outstanding at the beginning of the quarter. The company also announced a $1 billion increase to its stock repurchase program. CFO Meghan Frank commented: “Share repurchases remain our preferred method to return cash to shareholders, and I’m happy that our board has recently increased our authorization by $1 billion. With this new authorization, we now have approximately $1.7 billion of capacity to continue to buy back our shares.”
Given that Lululemon is trading at one of its lowest multiples in history, it’s reassuring to see management putting excess cash to work on behalf of shareholders.
Final Thoughts: Navigating Through Temporary Headwinds
I believe that the headwinds in the Americas are temporary. With Lululemon’s strong brand loyalty, innovative product offerings, and commitment to customer experience, the company is likely to recover and achieve continued growth.
The slowdown in Americas sales primarily stems from Lululemon’s missteps in their women’s assortment, particularly in core leggings, where limited color options and size availability affected sales. While they’ve taken steps to rectify these issues, the initial impact underscores the importance of closely monitoring management’s ability to address inventory planning and assortment challenges effectively.
The company did acknowledge a dynamic consumer environment, but their focus remained on internal issues as the primary cause of the slowdown. Despite these challenges, Lululemon’s strong performance in international markets, particularly China, underscores the brand’s global desirability and growth potential. I believe that these headwinds in the Americas are temporary.
With Lululemon’s strong brand loyalty, innovative product offerings, and commitment to customer experience, I believe that the headwinds in the Americas are temporary and the company is well-positioned to recover and achieve continued growth.
Disclaimer: This research reports constitute the author’s personal views only and are for educational purposes only. It is not to be construed as financial advice in any shape or form. From time to time, the author may hold positions in the below-mentioned stocks consistent with the views and opinions expressed in this article. Disclosure – I hold a position in Lululemon at the time of publishing this article (this is a disclosure and NOT A RECOMMENDATION).
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