Is Christine Day Worth $2 Billion

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Lululemon Athletica (NASDAQ: LULU) lost over $2 billion of market cap on Tuesday, after CEO Christine Day announced her resignation with the company’s first quarter results. Despite cries for her resignation since the company’s see-through pants debacle earlier this year, the big names in the stock apparently felt her announced departure was mistimed. So, estimate beating earnings results notwithstanding, the stock plunged 17.5%, seemingly all on the news of Day’s resignation.

Lululemon’s stock performance over the last five and a half years is a testament to Day’s leadership abilities. But is she really worth $2 billion?

Day’s days aren’t numbered

Day’s resignation is not a signal the the company is in trouble. Unlike recent departures at J.C. Penney or Groupon, Day wasn’t fired - at least not explicitly. Most importantly, Day will stay in her leadership role until a replacement is found. There is no need for an interim replacement, and no rush to find a full-time one.

Day’s announcement is reminiscent of Intel’s (NASDAQ: INTC) Paul Otellini’s announcement last year. Intel was going through some tough times, which Otellini navigated admirably, as the PC market declined and the company lagged behind in the mobile space. The stock took a hit with the announcement, but has since rallied back on the strength of its new portfolio of high-efficiency chipsets.

Similarly, Day’s resignation comes amid the company’s recovery from a PR fiasco, which I believe Day handled in the best way possible. Undoubtedly, the luon recall will suppress revenue and earnings for a few quarters, and Day’s impending departure may weigh the stock down until her replacement is announced and the cloud of uncertainty is lifted. Like Intel, however, Lululemon is a strong and profitable company.

Good results

Analyst’s estimates were tempered from the see-through pants recall in the first quarter, but that doesn’t change the fact that Lululemon performed better than expected.

Revenue came in at $345.8 million compared to analyst’s estimates of $341 million. That figure is a testament to how loyal the Lululemon customer base is.

The company also beat estimates on earnings with $0.32 per share compared to expectations of just $0.30 per share. While, revenue rose 21% over the same period a year ago, earnings remained flat.

This is mostly the result of the luon recall. Gross margin contracted 567 basis points - 510 basis points were attributed to the recall. Additionally, operating expenses grew as SG&A costs rose from 29.5% or revenue to 30.3% of revenue. Increasing overhead in the face of almost certain lost revenue was a bold move, and it appears to have paid off.

Better guidance

Lululemon has historically offered very conservative guidance, and then handily beat it (not unlike Apple’s previous MO). For its second quarter guidance, the company estimates numbers well ahead of where analysts pegged it.

Management expects revenue for next quarter to come in between $340 million and $345 million and earnings of $0.33 to $0.35 per share. Comparatively, analysts expected revenue of just $328.9 million and earnings of $0.33 per share. Considering Lululemon has exceeded the high end of its guidance for both revenue and earnings for 10 consecutive quarters, it’s likely those analyst estimates will increase.

For the full year, the company raised its revenue guidance to $1.645 billion to $1.665 billion, above analysts’ $1.64 billion expectation. Earnings are guided to come in at $1.96 to $2.01 per share. That’s in line with expectations of $1.99 per share.

With such strong guidance, Lululemon appears confident it can successfully get through the transition to a new CEO. Christine Day will continue her hard work until a suitable replacement is found, and I believe these numbers are quite feasible.

Finding a suitable replacement

In Day’s resignation announcement she said, “Now is the right time to bring in a CEO who will drive the next phase of Lululemon's development and growth.” Many expect that next phase of growth to be outside the United States and Canada.

But Lululemon will also have to pay closer attention to what’s going on closer to home. Gap’s (NYSE: GPS) Athleta brand and Under Armour (NYSE: UA) pose serious threats to Lululemon, and have made it clear yoga apparel is a key part of each company’s future. Their prices are generally much lower than Lululemon’s, and Gap is aggressively building Athleta stores near Lululemon locations.

Fool contributor Andrew Marder made an interesting point that Lululemon is now in a position where it could conceivably hurt its competition and help itself at the same time by pulling a manager from one of its biggest threats.

Gap’s Athleta portfolio manager, Art Peck, also has experience as President of Gap North America, which makes him a viable candidate for Lululemon to poach. The more interesting candidate Marder mentions, to me at least, is at Under Armour - Charlie Maurath.

Before being named President of Under Armour International, Maurath served in numerous executive roles at Adidas. He had numerous international successes, including nine years as President of adidas Latin America. The region was the fastest growing market within Adidas Group during his tenure.

With the next phase of growth almost certainly including international expansion, it would be quite a coup if Lululemon could land Maurath as Day’s replacement. If Day was worth $2 billion in market cap, Maurath ought to help recover at least part of that.

Another opportunity

Investors who missed out on the opportunity to buy back in March, may have another opportunity to buy at a similar price today. While the short-term outlook is uncertain due to Day’s impending departure and unknown replacement, the company’s financials are strong and its guidance is rosy.

Day did a fantastic job managing the company for five and a half years, but she’s not irreplaceable. I don’t think her resignation ought to trigger a $2 billion decrease in the value of the company, so at these levels, Lululemon looks like a great buy.

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Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Intel, Lululemon Athletica, and Under Armour. The Motley Fool owns shares of Intel and Under Armour. 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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