Are You Cuckoo to Invest In LULU?

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Lululemon’s (NASDAQ: LULU) once-rampaging stock now acts wounded and confused. The company’s investors are accustomed to drama, but its latest episode led the stock significantly lower and allowed doubt to creep into investors' minds.

CEO steps down

Lululemon CEO Christine Day announced that she will step down from her position for personal reasons. Since the news broke on June 10, the stock has suffered. Below is a one-month chart demonstrating this poor performance compared to peers Nike (NYSE: NKE) and Under Armour (NYSE: UA).

<img alt="" src="http://media.ycharts.com/charts/1daa00212fe454d7cbf3e9f242940595.png" />

LULU data by YCharts

Day plans to stick around until a suitable replacement is found, but it’s not likely that the company will find someone who can lead the company as well she has for the past six years. Under Day’s leadership, Lululemon has consistently improved its annual revenue and earnings.

Day’s announcement also came with speculation of insider trading by Chairman Dennis Wilson, who sold 2.3 million shares two days prior to the announcement. After details of the trade were released, it appears as though he’s clear from any wrongdoing. But his move still led to negative press, which hurt the stock price. 

First-quarter performance

Same-store sales improved 7% year over year, and direct-to-consumer revenue increased 40%. The cash position also increased 38.7%, and debt remains a foreign word at Lululemon. 

Also in the first quarter, Lululemon opened eight new stores and only closed one. The opening and closing of stores is important information for investors. It often indicates the confidence a company has in its future potential. If a retailer is opening more stores than its closing, then that company is likely confident in its future prospects. This, in turn, provides a quality hint to investors.

In another positive for the quarter, Lululemon upped its full-year earnings guidance to $1.96-$2.01 per share, from $1.95-$1.99.

Male clothing stores

One of Lululemon’s goals is to open men’s-only stores by 2016.  Lululemon attempting to make a significant impact on the menswear market is like a classy Italian restaurant trying to sell hamburgers. Lululemon’s brand is well established, and the word 'Lululemon' has a strong female connotation. Most men don’t want to wear a female brand, even if it’s the most comfortable fabric in the world. This severely limits Lululemon’s growth potential.

The only solution would be to run a massive advertising campaign to alter the company’s image, but that might increase costs too much, hurting the bottom line. And why would a man buy an $80 shirt from Lululemon when he can buy a similar shirt for half the price from Under Armour? 

For all these reasons, stealing market share from Under Armour and Nike will prove extremely difficult for Lululemon.

Conclusion

The good news is that Lululemon’s numbers continue to impress. If you believe in ignoring all the noise and just focusing on the top and bottom lines, then you might want to consider Lululemon as an investment. On the other hand, risks are now significant.

Lululemon is trading at 33 times earnings, which means expectations are high and there is little margin for error. Under Armour is also expensive at 50 times earnings, but the always-steady Nike is currently trading at 23 times earnings. In another plus for Nike, it’s the only company in this group that offers a dividend yield -- currently 1.40%.

Other negatives for Lululemon include downside stock momentum, a sudden and unexpected CEO departure, plans to open stores for men only (high risk), fierce competition, and insider trading speculation.

The most important point is Day’s departure. When a top-notch leader with proven results exits a company, it rarely leads to improved results down the road. These kinds of leaders are difficult to find, and they’re nearly impossible to replace.

Consider avoiding Lululemon at this time. Nike is the best and safest long-term option in the group.


Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica, Nike, and Under Armour. The Motley Fool owns shares of Nike 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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