Why Lululemon's Setback Could Be Your Next Big Win

Key Points

• Lululemon disappointed on revenue and lowered its full-year guidance in its most recent earnings report.
• The athleisure firm has struggled to match customer desires, citing its failed Breezethrough leggings launch and a lack of innovation as challenges.
• Still, efficient operations, a growing international presence, and restructuring its design and merchandising arms could position Lululemon for future success.

Lululemon Athletica Inc. NASDAQ: LULU had only a few bits of positive news when it presented results for the second quarter on August 29, and it's no surprise that shares of the athletic apparel company remain down more than 31% in the last year. Nonetheless, a close inspection of the firm's operations—taking into account ongoing challenges on both internal and external fronts—suggests that Lululemon may eventually regain its footing for investors willing to exercise patience.

Lululemon Adjusts Expectations as Near-Term Challenges Persist

Quarterly revenue of $2.4 billion represented a 7% year-over-year increase, with comparable sales growth of 2% over the same period. Lululemon missed analyst forecasts for both sales and comparable sales growth. Sales in the Americas—the company's core geographic region—were even more disappointing: net revenue increased by just 1% as sales declined by 3%.

Lululemon anticipates sluggish sales to continue through at least the current quarter. It estimated year-over-year sales growth for Q3 at between 6% and 7%, also shy of analyst expectations. The company lowered its full-year revenue guidance as well. It anticipates revenue for 2024 between $10.38 and $10.48 billion, down from an expected range of $10.7 to $10.8 billion.

Reconnecting With Customers Is Essential for Lululemon

One reason for Lululemon's recent and continued struggles with depressed sales and revenue may be a failure to connect with customers in the latest quarters. The highly-publicized failure of its Breezethrough leggings, launched in July and pulled from stores later in the quarter due to complaints about fit, illustrates this issue. However, CEO Calvin McDonald said in the company's earnings call that stopping sales on this product had a "negligible impact" on sales for the quarter.

Despite its overall strong brand recognition, Lululemon is wrestling with at least two major barriers to connecting with its athleisure customers. First, the company has faced more competition in this space than ever before in recent years, particularly as rivals like Alo Yoga have risen to prominence through a marketing strategy centered around social media influencers. Vuori is another competitor that encroaches on Lululemon's market share, particularly given its focus on menswear, a segment in which Lululemon is historically weak.

A second impediment is the May departure of Chief Product Officer Sun Choe, a longtime creative force behind many of Lululemon's top products. Choe left the company to take a position as Global Brand President of the Vans brand for VF Corporation NYSE: VFC. At a time when McDonald's acknowledged that Lululemon's women's business had slowed because of a lack of new product styles, the void left by Choe was particularly damaging.

LULU's Focus on the Positives: Operations, International Markets, Restructuring

At a time when retailers across industries are feeling pressure due to waning demand, there are nonetheless reasons why Lululemon may stabilize in future quarters. First, the company's operations are efficient: gross margin increased by 80 basis points to 59.6%, and operating margin and operating income climbed in the last quarter. Cost discipline has been key to Lululemon's bottom-line performance, as the company's net income increased by 15% to $391 million, beating expectations. Lululemon expects to maintain this operational efficiency as it predicted third-quarter earnings per share between $2.68 and $2.73, which aligns with analyst expectations despite lackluster revenue forecasts.

Another bright spot for Lululemon is international sales. The market abroad seems ripe for growth—quarterly net revenue in China surged by 34% year-over-year, driving overall international revenue improvement of 29%, thanks in part to its viral "Summer Sweat Games" events. McDonald's says the company expects to quadruple 2021 international revenue levels by 2026.

Investors willing to be patient should watch as Lululemon continues navigating Choe's departure. The company appointed longtime Nike Inc. NYSE: NKE global brand marketing leader Nikki Neuberger as its new chief brand and product activation officer and restructured its design and merchandising arms.

Upside Potential Remains for Lululemon

Despite challenges in the near term, analysts are optimistic about Lululemon. It enjoys a Moderate Buy rating and 45% upside potential based on an average price target of $375 per share. However, to capitalize on that potential, investors may need to wait for the company to address some of the above concerns.