This Company Has a Visibility Problem

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Lululemon Athletica (NASDAQ: LULU) is a very special business, the company has unique brand power and is particularly well positioned to benefit from the yoga boom in the middle term. Now that the stock is down nearly 25% from its highs a few days ago, investors may feel tempted to buy some shares of this high-growth company at discounted prices. Invest at your own peril though; there are some serious visibility problems with this company.

Leadership

Lululemon has taken a beating since the company reported earnings on June 10; the stock was trading above $82 back then and is now below $64 per share. The earnings report was not the problem; numbers were actually better than expected, but investors felt surprised and concerned when they learned that the company´s CEO, Christine Day, is leaving Lululemon.

Transparency has been a real problem for Lululemon lately. The company had to recall 17% of all women’s bottoms in stores back in March due to "increased sheerness" as the company put it. This caused some public relations damage, and it cost Chief Product Officer Sheree Waterson her job.

But Lululemon has already fixed that problem; pants are back on the shelves and it doesn´t sound like something serious enough to merit the departure of a successful CEO like Day. Since she became CEO five years ago, the company has increased sales at a compounded annual growth rate of 38.5%, and earnings per share grew even faster at 51.9% per year.

Christine Day led Lululemon through a booming growth phase, so it´s unlikely that she was forced out by the board because of the see-through pants issue. But she said she was leaving because of “personal reasons,” which is the typical phrase corporate executives use when they don´t really want to give any explanations, so investors could really appreciate more information.

Successful CEOs don´t usually leave this way: in a sudden, unexpected manner and without a successor in place. It was quite easy to anticipate that this was going to be seen as troubling news by the market, and this makes the move even more suspicious. It´s hard to tell what it is, but it looks like there may be something else going on here.

Competition

Another area in which Lululemon is lacking visibility is in its ability to sustain growth rates in the face of increased competitive pressure. The company´s success has attracted a lot of competition, and whether Lululemon is up to the challenge remains to be seen.

Gap (NYSE: GPS) is aggressively going after Lululemon with its Athleta brand. Athleta is opening new stores near existing Lululemon locations, benefiting from its traffic and undercutting Lululemon products in price. In addition to that, Athleta is copying Lululemon´s marketing strategy by hooking up with yoga instructors and sponsoring all kinds of classes and similar activities. 

Nordstrom (NYSE: JWN) has also launched its line of yoga athletic wear called Zella. The company has reportedly hired a Lululemon alum to be in charge of product design, and Zella products are in fact quite similar to those of Lululemon, at least as far as the eye can tell. Nordstrom caters the same affluent clientele as Lululemon, but Zella products are more affordable. Besides, Zella also comes in plus and kid sizes, which gives it a more family oriented image.

If we are talking about athletic wear, Nike (NYSE: NKE) cannot be left out from the discussion. The company is the undisputed industry leader on a global scale, and it has a geographic reach and marketing budget well above Lululemon. Nike has its own line of yoga apparel, and in November it launched the Nike Studio Wrap, a footwear product targeted at women who favor studio workouts like yoga.

Lululemon seems to be feeling the pressure: performance is still quite strong, but growth seems to be clearly decelerating. Same-store sales growth fell from a much higher 25% in the first quarter of 2012 to 7% annually in the first quarter of this year. Production problems may explain part of this slowdown in growth, but increased competition and business maturation are also important factors to consider.

Lululemon is still the high-end leader, and the company has a lot of room for international expansion, but the company seems to be entering a phase of slowing growth rates and increased competitive challenges, so investors need to closely monitor management´s ability to deal with this transition. Unfortunately, we don´t know who will be Lululemon´s CEO over this important period.

Bottom line

Maybe the recent weakness in the stock will turn out to be a huge buying opportunity, or perhaps management turmoil is a sign of deeper problems in a business going through a challenging phase. The point is that there is not enough visibility to make a comfortable decision at this point in time, so staying on the sideline is probably the smart thing to do.

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Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica and Nike. The Motley Fool owns shares of Nike. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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