Lululemon Low-balls Guidance Again
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Lululemon (NASDAQ: LULU) dropped sharply on Thursday after providing lower than expected revenue and earnings forecasts. The first quarter results itself were stellar: 52% revenue growth, 25% same-store-sales growth, and 39% earnings per share growth. However, they provided full-year 2012 guidance that was below analysts expectations:
- Revenue of $1.32 - $1.34 billion
- Earnings per share of $1.55 - $1.60
Investors are also concerned about Lululemon's rising inventory, a valid concern given that this is often a red-flag for deteriorating businesses. For a case study in rising inventory issues, let's take a look back at Crocs (NASDAQ: CROX). Back in late 2007, Crocs was flying high as a growth stock, up around $70. Between then and mid-2008, it dropped into the single digits. What tipped off investors that Crocs might be headed the wrong direction? Inventory increases.
If you listened to the quarterly conferences calls, you heard management try to explain away these increases. The explanations were lame. I was an investor in Crocs and the explanations didn't make much sense. The stock sold off after the first big inventory increase, but a one-time inventory increase doesn't necessarily mean it's a trend. Mindful of the importance of inventory levels, I continued to hold the stock with a focus on whether it would report the same inventory trend in the following quarter. The next quarter, Crocs again showed significantly elevated inventory levels. The reasons provided again didn't make sense. I sold the stock and saved myself from a huge loss (and headache).
So how does Lululemon's inventory increase compare to this? Should we be worried about their rising inventory? Afterall, Lululemon executed just fine at the previously lower inventory levels. So why the higher inventory? After not being able to meet some sales in 2011 because they ran out of certain items, management is determined not to repeat that history going forward. That is a perfectly reasonable explanation and makes sense given that Lululemon wants to stay in growth mode. However, investors need to keep an eye on these inventory levels going forward as a potential red flag.
The reason for the increased inventory levels also doesn't match the company's forecast for 2012. Interestingly, despite beating expectations in the first quarter, Lululemon's management left their full-year guidance unchanged. In doing so, they are effectively saying that Lululemon's results will decelerate going forward. Increasing inventory levels to help sales doesn't make a ton of sense if you're not projecting corresponding sales and earnings increases. Perhaps the answer lies in looking at Lululemon's history.
Lululemon has a solid history of low-balling forecasts and lowering investor expectations. We've seen multiple occasions of Lululemon stock struggling after reporting good earnings because management provided more moderate projections than analysts expected. In this current case, keeping their 2012 guidance unchanged does not match the story of a business continuing to expand rapidly. Management expects to open 35 stores this year from a current base of 180 stores. They also expect to continue international expansion, particularly in Australia and New Zealand, but also in the US where there are only 75 stores. Furthermore, same-store-sales are expected to be in the low-double digits. That's lower than their historic same-store-sales growth, but clearly is not indicative of a softening business.
Like any super-growth stock, Lululemon has an expensive valuation. Using the low-end of management's guidance for 2012, the $1.55 EPS and current $64 stock price calculates to a forward P/E of 40.6. The $1.55 EPS for 2012 would provide 22% growth over 2011 and a forward PEG ratio of 1.85. That's a typical valuation for a high-growth company and shows that the market adjusted accordingly to management's disappointing guidance.
Helping support a premium valuation is their rock-solid balance sheet and lack of yoga apparel specific competition. Their balance sheet boasts $424 million of cash and zero long-term debt. As for the competition, there really is no direct competitor to Lululemon. Companies such as Nike (NYSE: NKE) and Under Armour Inc. (NYSE: UA) provide alternatives to consumers, but don't hit directly on the niche that Lululemon dominates. Calling Nike and Under Armour competitors to Lululemon is a little like saying that Whole Foods competes with Safeway and Kroger. While they can all be called grocery stores, Whole Foods clearly targets a more specific, higher-end market than Safeway and Kroger, who cater to the general public. Similarly, Lululemon mostly serves a very focused niche yoga market, where they are able to successfully charge high prices for their specialty apparel. Nike, Under Armour and others provide sportswear than can substitute for Lululemon, but no major company provides any direct, significant threat to Lululemon in the niche yoga market.
If you have been waiting for a sell-off in the richly valued Lululemon, then your time has arrived. Management disappointed the market by keeping their 2012 guidance unchanged. The market reacted accordingly by adjusting the valuation to match management's guidance. However, Lululemon has a history of lowering expectations and giving investors a great entry point like the one we have now. If management's unchanged guidance really does hold true, then the inventory level issue will be front and center. If Lululemon can beat their lowered expectations again, then $64 will look mighty cheap by the end of the year.
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