Lululemon Shares Are Being Shredded, But Is This an Opportunity?

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Lululemon Athletica Inc. (NYSE:LULU) is a pretty well-known company. It has had an interesting history, and it caught my eye today after dropping to a three-year low on the back of stale earnings and disappointing guidance.

For those unfamiliar, the company designs, manufactures, and distributes athletic apparel and accessories for women, men, and female youth. It operates in three segments: Corporate-Owned Stores, Direct To Consumer, and Other Sales. The company’s line of apparel include fitness pants, shorts, tops, and jackets for healthy lifestyle activities, such as yoga, running, and general fitness. Its fitness-related accessories comprise bags, socks, underwear, yoga mats, and water bottles. The company sells its products through a chain of corporate-owned and operated retail stores; direct to consumer through e-commerce websites; and a network of wholesale channel, such as premium yoga studios, health clubs, and fitness centers. Should you consider buying the stock here, or avoid it?

Well, the growth story seems to be closing on this one. But it could be a take-over target. Let’s review the numbers. Net revenue for the quarter increased 11 percent to $384.6 million from $345.8 million in the first quarter of fiscal 2013. Total comparable sales on a combined basis increased just 1 percent for the first quarter on a constant dollar basis. Comparable corporate-store sales for the first quarter decreased by 4 percent on a constant dollar basis and direct to consumer revenue increased 25 percent on a constant dollar basis. Direct to consumer revenue increased to $66.0 million, or 17.2 percent of total company revenues, an increase from 15.6 percent of total company revenues last year. Gross profit for the quarter increased 15 percent to $195.7 million, and as a percentage of net revenue gross profit increased to 50.9 percent for the quarter from 49.4 percent last year.

Income from operations for the quarter increased 6 percent to $69.8 million, and as a percentage of net revenue was 18.2 percent compared to 19.1 percent of net revenue last year. Tax expense for the quarter was $52.5 million, which included a one-time adjustment of $30.9 million for the planned repatriation of foreign earnings that will be used to fund the share buyback program. The normalized tax rate before the $30.9 million non-recurring adjustment would have been 30.1 percent, compared to 29.8 percent a year ago. The tax rate for the first quarter of fiscal 2014, including the one-time adjustment, was 73.4 percent. Overall, excluding the one-time adjustment, diluted earnings per share were $0.34 in the first quarter of fiscal 2014. This actually beat consensus.

The company ended the first quarter of fiscal 2014 with $752.0 million in cash and cash equivalents compared to $588.4 million at the end of the first quarter of fiscal 2013. Inventory at the end of the first quarter of fiscal 2014 totaled $177.4 million compared to $143.7 million at the end of the first quarter of fiscal 2013. The company ended the quarter with 263 stores.

CEO Laurent Potdevin said, “We are pleased that Q1 results were slightly ahead of our expectations. 2014 is very much a transitional year for Lululemon, and we are on track with the improvements we have set out to achieve. We are focused on building a scalable foundation to further elevate our North American business and pursue the brand’s incredible international potential. Despite a reduced outlook, I am confident that the work we are doing today will only enhance our premium positioning as we continue to lead as the market innovator.”

It is that reduced outlook that is hammering shares down to three-year lows. To be honest, shares are a bit intriguing at these levels. For the second quarter of fiscal 2014, the company expects net revenue to be in the range of $375 million to $380 million based on a total combined comparable sales decrease in the low to mid-single digits on a constant-dollar basis. Diluted earnings per share are expected to be in the range of $0.28 to $0.30 for the quarter. For the full fiscal 2014, it expects net revenue to be in the range of $1.770 billion to $1.800 billion based on a total combined comparable sales increase in the low single digits on a constant-dollar basis. Diluted earnings per share are expected to be in the range of $1.50 to $1.55 for the full year, or $1.71 to $1.76 normalized for the one-time tax adjustment related to the planned repatriation.

No doubt these numbers are disappointing. But, the company does have one thing going for it. A share repurchase plan. Its board of directors has approved a stock repurchase program to buy back up to $450 million of its common shares in the open market at prevailing market prices. The timing and actual number of common shares to be repurchased will depend upon market conditions. For the long-term, this is a sound approach. While many of my analyst colleagues are heading out of this stock, reducing their ratings to hold/sells, I am going to buck the trend and say that at three-year lows, the company is worth a small position while it works to get back on track. Thus, at $37.50 I think a position can be started, and so I recommend a buy and assign a $44 one-year price target.

Disclosure: Christopher F. Davis holds no position in Lululemon Athletics but may initiate a long position in the next 72 hours. He has a buy rating on the stock at $37.50 and a $44 price target.

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