Lululemon Athletica Falls Down as Holiday Season Worries Mount

Image: Lululemon Athletica.

The athletic-apparel business has been hot lately, and the popularity of yoga helped retail specialist Lululemon Athletica become a household name among fitness-conscious shoppers. Even after its struggles with quality control, Lululemon had shown signs of recovery. Coming into Wednesday's fiscal third-quarter financial report, Lululemon investors had hoped that the retailer would be able to carry some positive momentum into the key holiday season.

Unfortunately, Lululemon threw cold water on those hopes, guiding its sales and earnings for the current quarter below levels that investors wanted to see. That could well open the door to competitors like Gap and their own lines of athletic apparel. Let's take a closer look at Lululemon's latest results and guidance to see if the negative reaction shareholders had is justified.

Lululemon posts mixed resultsLululemon's fiscal third-quarter results showed some of the challenges that the yoga-apparel retailer has faced lately. Revenue rose 14%, to $479.7 million, which was slightly slower than the 15% growth rate that investors had expected. Net income declined 12%, to $53.2 million, but the resulting earnings of $0.38 per share was $0.01 better than analyst estimates, despite falling from last year's $0.42 per-share level.

Looking more closely at Lululemon's results, the retailer again suffered headwinds from the strong U.S. dollar. Total comparable sales rose 3% for the quarter, but if you back out the impact of weaker foreign currencies, constant-dollar comps jumped a more impressive 9%. Comparable-store sales for its retail locations were flat before adjusting for the same six-percentage-point currency impact, but the direct-to-consumer channel was strong once again, with a jump of 21% in constant-dollar terms.

Margins continued to plague Lululemon during the quarter. Gross margins fell by more than three percentage points, to 46.9%, and operating margins took an even steeper decline of more than five percentage points, to 14.2%. Rising overhead expenses contributed to the margin contraction that Lululemon saw, offsetting a substantial drop in income-tax-related expenses.

Lululemon CEO Laurent Potdevin accentuated the positives in the report. "We had a solid quarter in line with our expectations," Potdevin said, "underscored by the combination of our product, guest, and community initiatives along with tremendous guest reception to major store openings around the world." The CEO also believes that the organizational changes that Lululemon has implemented should pay off in long-term value over time.

Can Lululemon Athletica pick itself up? The problem that Lululemon faces is that its holiday-quarter results could come in well short of what investors had expected from the company. Guidance for the fiscal fourth quarter included sales in a range of between $670 million and $685 million, which is below the consensus forecast for $690 million. Earnings of between $0.75 and $0.78 per share for the quarter would be an even larger shortfall in percentage terms from the expected $0.86 per share among investors.

Similar concerns show up in Lululemon's updated guidance for the full fiscal year. A new revenue range of $2.025 billion to $2.04 billion cut the top-end of the previous range by $10 million, and full-year earnings of $1.81 to $1.84 per share would be more than $0.05 less than the company had projected this time last quarter.

Competitors are also seeking to capitalize on Lululemon's weaknesses. Gap, for instance, has continued to grow its network of Athleta stores, and Gap expects 120 locations in the U.S. by the end of the fiscal year. The athletic-apparel division still represents a small part of Gap's overall revenue, but many investors have been encouraged by Gap's efforts to broaden its appeal, and eat into Lululemon's once-formidable dominance of the space.

Lululemon continues to bolster its stock's prospects with ongoing stock buybacks. During the quarter, Lululemon repurchased 1.6 million shares, paying an average of $55.50 per share, and spending just shy of $89 million in total. That pace of repurchases is faster than in previous quarters, and represents the confidence that the retailer has that its shares don't accurately reflect the company's potential.

The guidance cut spooked Lululemon investors, and the stock fell 10% in pre-market trading following the announcement. With so much riding on a successful holiday season, Lululemon will need to surpass its poor expectations by a considerable amount in order to reassure shareholders who have already been hit hard by the retailer's past problems.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Lululemon Athletica. 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.

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