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Lululemon (LULU) Crashes 10% Despite Crushing Earnings Expectations

By: , dated June 11th, 2012

Lululemon Athletica (LULU: Charts, News), the yoga apparel retailer that took the world by storm last year as Wall Street’s favorite growth stock, was crushed last week despite reporting a 39% gain in profit and a 53% jump in revenue from the previous year. The Vancouver-based retailer, which specializes in high-priced yoga gear and running apparel for young women, reported first quarter earnings of 32 cents per share, or $46.6 million, on revenue of $285.7 million. Analysts on average had expected Lululemon to earn 30 cents per share on revenue of $270.9 million. Despite beating on both the top and bottom lines, Lululemon shares plunged nearly 10% on Thursday and Friday, due to lower than expected sales guidance, shrinking margins and rising expenses. Lululemon’s crash also dragged down other momentum retail stocks, such as Michael Kors (KORS: Charts, News) and Coach (COH: Charts, News).

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Looking forward, Lululemon expects to earn $1.55 to $1.60 per share for fiscal 2012, which fell shy of the average analyst consensus of $1.62 per share. The company expects to finish 2012 with $1.32 billion to $1.34 billion in revenue, which missed the analyst forecast of $1.35 billion. Gross profit margin dipped from 58.7% to 55% from the prior year quarter. Higher labor and material costs, combined with more markdowns, caused the drop in margins.

Higher store labor and operating costs also caused an alarming 45.1% increase in selling, general and administrative expenses. Brian Sozzi, an analyst at NBG Productions, stated, “They’re putting more costs behind their product, and if you look at some of the new releases on the site, there’s just a lot of embellishment, and I don’t know if the consumer is willing to pay some of the prices I’m starting to see.” Sozzi called Lululemon’s current troubles “growing pains” for a rapidly expanding company. Sozzi also noted that Lululemon’s inventory increased 67% over the previous year, from $64.4 million to $107.7 million – a clear sign that the company’s supply is outpacing demand.

Lululemon was able to grow same store sales by 25% during the first quarter, but warned that growth in the second quarter could drop to a percentage in the “low double-digit range. Shares are trading at a premium to its industry peers, at 39 times forward earnings. Meanwhile, Nike trades at 19 times forward earnings and Under Armour trades at 33. This suggests that a significant amount of growth expectations have already been priced into the volatile stock. Sternee Agee analyst Sam Poser acknowledged the company’s long-term growth potential. “It trades at a high multiple, it’s a big growth story,” Poser stated.

Due to its high volatility – its beta its 2.48 – Lululemon shares are heavily shorted. In fact, Lululemon ranks fifth in terms of short interest on the NASDAQ, which 10.8% of floated shares being shorted at the end of May. This high short interest could lead to the inevitable short squeeze, which could give the stock momentum to bounce back to higher levels. Shares have bounced in a wide 52-week range between $41.70 and $81.09.

Lululemon, which went public in 2007, is still a young company with a small footprint – with 180 stores in North America, Australia and New Zealand. Shares have risen over 350% since its market debut. Shares currently have a 5-year PEG ratio of 1.4, and do not pay a dividend.

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Leo Sun Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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