Frankly, the temptation to make truly awful puns about Lululemon Athletica inc. (NASDAQ:LULU) and its see-through pants recall is overwhelming. Like others I had drunk the Lululemonade and had been bullish since last summer.
When quality control goes downward dog
The quality control issue Lululemon Athletica inc. (NASDAQ:LULU) management blamed on its supplier of Luon fabric, Eclat Textile of Taiwan, a decade long supplier, and spun (OK, one pun) as only a recent problem is disingenuous. Lululemon has a huge following on the web with fan blogs solely devoted to the Canadian manufacturer of yoga, biking, swim, and running apparel. Several with the largest followings and most devoted bloggers have chimed in that this transparency issue has been a long time complaint and the company was growing margins at their expense.
Credit Suisse analyst Christian Buss had noted there were four quality control issues in one year alone and that the company could alienate its loyal customer base. Last August a color bleeding problem was reported. Other analysts have posited that loyal customers could easily migrate to Nike and Under Armour while the recalled products were unavailable. Stern Agee analyst Sam Poser downgraded to neutral but Sam Lee of International Strategy and Investment Group said this is a buying opportunity while the company focuses on its supply chain problems.
The worst part is blogger Lululemon Addict reported when returning some pants affected by the recall she was asked to bend over to be inspected by one of the Lululemon Athletica inc. (NASDAQ:LULU) “educators” to determine the sheerness of the pants. Similar anecdotes pop up on the fan sites and in the media.
It’s a shame it’s come to this. When it came to fabric innovation, building a niche brand, growing a fervent customer base, and online marketing few companies could beat Lululemon Athletica inc. (NASDAQ:LULU). These were the main reasons the stock climbed from under $5 in 2009 to $50 before they had a 2:1 split in 2011. According to Q4 results the direct to consumer sales alone increased 56%. Before this recall analysts had predicted a 24.37% five year EPS growth rate.
The details of construction were what made the yoga pants such a favorite with “vintage” pants from just a few years ago pre-IPO still doing brisk business on eBay. What other line of clothing beside haute couture finds fans discussing the resale value as if it was an investment?
CEO Christine Day told the Wall Street Journal almost a year to the day regarding returns and customer service, “We aren’t Nordstrom. We aren’t your personal shopper.” I have a feeling that one is coming back to bite her as their reputation for quality goes downward dog.
Is the stock still investible?
What makes all this more troubling is that Day has been selling a pantload of shares (over $20 million worth). So has founder Dennis “Chip” Wilson. As of the end of 2012 Day has only 35,232 shares left and Wilson around 25,000.
The stock is trading after earnings at a 33.70 P/E and a 1.29 PEG. It’s more affordable now but their mishandling of ongoing quality issues and their bizarre “bend over” response can’t be denied as reasons to be wary. While they have hired more quality control personnel, it may be too little, too late. The short interest stands at 29.70%.
According to their earnings report on March 21 for full year and Q4 2012 this Luon pants recall will hit the bottom line for $57-67 million. To be fair, gross profit and net revenues increased 31% in the quarter compared to the year ago period. Diluted EPS increased from $0.51 to $0.75 from a year before. Cash (and cash equivalents) rose from $409.4 million to $590.2 million.
Pants profits elsewhere
As mentioned before there are yoga pant and athletic wear alternatives and two are preferable to Nike and Under Armour because their yoga pants are less stylish and feminine. (Also, Under Armour has no yield and its P/E at 41.82 is now higher than Lululemon.) Those two are The Gap Inc. (NYSE:GPS) with its Athleta line of athletic apparel and Limited Brands, Inc. (NYSE:LTD) whose Victoria’s Secret Pink yoga pants were being snapped up even pre-I see London, I see France controversy.
Consider Limited Brands, Inc. (NYSE:LTD) with its 2.80% yield and 17.37% P/E and a 1.29 PEG. I stopped into Victoria’s Secret on a Saturday afternoon and it was packed, with four registers all busy. The overwhelming majority of shoppers there were under 30 when I peeked in. Its PINK line aimed at college-age women and younger has helped pump up earnings 17% in the last quarter.
Limited Brands, Inc. (NYSE:LTD) which owns high end Henri Bendel, Bath and Body Works, La Senza, C.O. Bigelow, and White Barn Candle Company is off some 15% from its 52 week high. Limited Brands is a more global company than Lululemon Athletica inc. (NASDAQ:LULU)(only in New Zealand, Australia, Canada, and the US) with Limited Brands, Inc. (NYSE:LTD) stores in the Middle East and Europe as well as Canada and the US. Limited paid $1.44 billion to shareholders in 2012 and repurchased $625 million worth of shares.
The Gap Inc. (NYSE:GPS) is the largest of these with 3,300 stores in 90 countries. It has a 15.30 P/E and a 1.70% yield. Its Athleta brand is one of five main brands including Gap, Old Navy, Banana Republic, and Piperlime.
The Gap Inc. (NYSE:GPS) is closer to its 52 week high, up 34.77%. Analysts expect a 9.47% five year EPS growth rate for Gap, less than half that of Lululemon. The Luon pants shortage will likely be a minimal catalyst for The Gap Inc. (NYSE:GPS).
Let’s sew it up
I prefer Limited Brands, Inc. (NYSE:LTD) to The Gap Inc. (NYSE:GPS) for upside, yield, and the increasing following for PINK. With Lululemon Athletica inc. (NASDAQ:LULU) there was so much to love: its community outreach, its growth, and the fervor shown by its customers. As their manifesto said, “Friends are more important than money.” Friends don’t sell see-through pants and then ask you to bend over.
The article Seeing Through Lululemon’s Excuses originally appeared on Fool.com.
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