L Stands for Long LULU
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Lululemon Athletica Inc. (NASDAQ: LULU) announced its second-quarter earnings of fiscal year 2012, which came well ahead of expectations, boosted by higher sales of its upscale yoga wear and a favorable tax adjustment.
Shares of the company are currently up 12% on the positive earnings, and are reaching for its old high at 81. The current 52-week range is $41.70 to $81.09. This is remarkable since it had already moved up over 44.1% since the beginning of August while looking forward to earnings. Hard to believe there were still shorts to squeeze after the 44.1% run-up in August. They have more than quadrupled over the last two years.
Gains on Tax Adjustments
Profits jumped almost 50%, to $57.2 million, or 39 cents per share, up from $38.4 million, or 26 cents per share, in the same quarter last year. Revenue rose 33% to $282.6 million, driven by 15% surge in comparable store sales on a constant dollar basis. A comparable store sale is a key measure of a retailer's health, because it excludes revenue from stores that opened or closed recently. A very strong performance came from direct-to-customer sales, which climbed 91% to $35.4 million.
The positive reaction in shares is primarily related to the sustainability of a lower tax rate (next year expected to be approx 30%) based on a management review of the impact of inter-company pricing agreements. Excluding this tax adjustment of a $7.2 million, profit was 34 cents a share.
Lululemon guided Q3 and full-year EPS over views to a range of $1.76 to $1.81 per share, on revenues of $1.35 billion to $1.36 billion and that’s ahead of analysts’ expectations of $1.63 per share on $1.35 billion in revenue. It sees Q3 revenue of $300 million to $305 million, with same-store sales in the low- to mid-teens.
Lululemon's colorful, form-hugging clothes are ubiquitous in Canada, especially among affluent young women, and the brand is becoming increasingly popular in the United States. But that has also created supply problems in its stores, where its body hugging pants, shorts and tops fly off the shelves faster than they can be restocked.
Lululemon opened its first store in 1998 in Vancouver and has expanded to 137 stores in the past decade. Lululemon plans to continue expansion into more international markets with its yoga and running apparel and won't shift its brand to fashion wear.
It plans to open 35 corporate-owned stores plus two outlets in fiscal 2012, while noting that its e-commerce business is growing rapidly as well. In North America, much of Lululemon's growth is expected to come from outside its core urban markets such as New York, Los Angeles, Chicago and Boston.
Quality and Infringement Issues
Quality is key to Lululemon's business. From early on, the buzz was that Lululemon pants would last forever, but of late some quality issues were cropped up. The retailer is learning from its mistakes, including problems of bleeding colour dyes and discontinuing a popular pair of loose-fitting pants, which prompted customer complaints. It said it would bring back its so-called “still” loose-fit pants in a “reinvented” way. While bulls rightly observe that every apparel company has periodic issues with defective product, managing its image is critical for lululemon, so they cannot afford to screw up here.
Lululemon is suing Calvin Klein Inc. - one of the world's most famous designers - for patent infringement, accusing the designer of copying a waistband used on its popular body-hugging pants. Calvin Klein sells pants under its "Performance" brand that include the same waistband design elements and pant style, all of which are covered by the Vancouver company's patent. Lululemon is also making it hard to copy its styles.
On the design side, Lululemon has gained renown for its innovative use of fabrics and technology. Its Luon fabric is designed to wick away moisture, move with the body and reduce irritation. Its Silverescent brand incorporates silver directly into the fabric to reduce odors.
The popularity of its brands has helped Lululemon become one of the fastest-growing names in the specialty retail sector. None of its rivals has managed to match Lululemon's success at the higher end of the athletic apparel market. But that hasn't stopped a growing number of companies from trying to get a bigger piece of the market by offering lower prices on similar designs.
Lululemon made yoga apparel fashionable with its signature $98 pants, but it now faces rising competition from heavyweight brands at lower prices. Some of the best-known and most successful names in apparel, including Under Armour (NYSE: UA), Gap (NYSE: GPS), Nike (NYSE: NKE) and PVH Corp (NYSE: PVH).
Nike reported a 7.6% decline in net income for the first quarter of 2012 on account of higher product costs, as well as rising selling and distribution expenses. Gap opened 11 standalone Athleta stores last quarter, bringing its total to 22. The banner features workout gear and free in-store fitness classes, like the free yoga classes that helped build Lululemon's profile.
Under Armour have continued to grow their women's lines (now almost 30% of the business) with products such as the Under Armour bra. Management specifically mentions kids apparel and golf products as areas of strength.
PVH, an apparel retail company, is up 5.7% in following its earnings release. It consists of established brands like Calvin Klein, Heritage Brands (Van Heusen, ARROW etc), Tommy Hilfiger and licensed brands like Michael Kors and DKNY
LULU continues to fool the market and surprise with its continued growth in the face of lower-priced competition and a global slowdown. Their high margins are dropping slightly, and that may continue if they sacrifice margin for revenue growth and continue to grow inventories. Gross margins are somewhat lighter than the same period a year ago, now at 55.1% compared with 57.5% in the second quarter of 2011.
Although this remains one of the strongest-growing and most productive stories in retailing, valuation and expectations look more than a little breathless. Lululemon exited the second quarter of 2012 with cash and cash equivalents of $444.3 million, exhibiting an improvement of 67.9% from the end of the second quarter of 2011.
Lululemon currently trades at a significant premium to the peer group with a forward P/E of 42.7, higher Price/Book ratio of 16.4 and PEG ratio of 1.5 times. This suggests that the company has a dominant operating model relative to its peers. LULU currently converts every 1% of change in annual revenue into 1.3% of change in annual reported earnings.
I view this company as a leader among its peers. In my mind, there is an incredible level of expected growth, and one that I just cannot support. Consequently, I continue to admire what Lululemon management has built in terms of a business, but I just cannot get similarly excited about the shares.
Riddhi2406 has no positions in the stocks mentioned above. The Motley Fool owns shares of Lululemon Athletica and Under Armour. Motley Fool newsletter services recommend Lululemon Athletica, 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.If you have questions about this post or the Fool’s blog network, click here for information.