Not any more

Lululemon: a newer Nike … or Heelys? – The Globe and Mail

In Canada on September 29, 2010 at 19:36

Lululemon Athletica Inc. (LULU-Q45.19-0.64-1.40%) shares have jumped 43 per cent in the past year, but investors in the yoga-sportswear retailer may want to take a deep breath.

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lululemon athletica  (LULU-Q)

45.19     -0.64   -1.40%
As of Sep 29, 2010 4:00
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Can Lululemon maintain momentum or is it a consumer fad whose shares are destined to become a downward dog?

The Vancouver -based company, founded in 1998, doesn’t advertise much, but rather relies on word-of-mouth recommendations among its buyers, predominantly female yoga enthusiasts. That’s a finite market – something that should make investors wary.

Lululemon offers in-store yoga classes to leverage sales among followers of the ancient, ascetic practice. It also gives free gear to yoga instructors as a marketing tool.

Lululemon’s upscale customers, who admit to a “cult-like” following of the company’s products and typically pay more than $50 for an athletic top, may not be affected by general shopping trends. Still, consumer confidence unexpectedly declined in September to a one-year low.

A key question is whether Lululemon’s product appeal can reach beyond the urban areas of the yoga hotbeds on the U.S. east and west coasts. And, if it does, would other sports-apparel retailers, such as Nike and Under Armour, tap into the market and crush the upstart.

It’s rare for a public company to capitalize on such a small, unquantifiable market – in this case, sports-specific women’s athletic apparel, although it’s been done. Nike started as a designer and seller of distance-running shoes, for example. But for every Nike and Crocs, the seller of quirky shoes whose shares have more than doubled this year, there is a Heelys (HLYS-Q2.420.020.84%), the maker of shoes with a wheel in the heel. It once traded over $9 a share, and is now at $2.44.

Shares of Lululemon, which has a market value of $3-billion, have soared 44 per cent as earnings have grown, outpacing the 7.8 per cent gain of the Russell 2000 Index this year.

In its most recent quarter, the company reported a 56 per cent rise in revenue, including a 31 per cent increase in same-store sales. In its current fiscal year, which ends in January, the company is projecting earnings of $1.18 to $1.22 per share.

But in another warning flag, this one raised by its management, Lululemon is a novice at retailing. John Currie, its chief financial officer, told Bloomberg News in a recent interview that the 35 U.S. stores the company opened in 2008 were the least productive in its history because it didn’t research the communities, income levels and demographics of the locations adequately.

“Thank God for the recession – it forced us to slow down and actually approach our real estate strategy in a disciplined way,” he said.

The apparel maker has 75 owned and franchised stores in the U.S., with a goal of expanding to 300, although it hasn’t offered a time line. It ended the second quarter with 130 stores in North America and Australia. It opened its first store in 2000 in Vancouver and had its initial public offering in 2007.

Lululemon garners six “buy,” eight “hold” and one “sell” rating from analysts, about the same as a year ago. Its shares carry a price-to-earnings ratio of 33.3, almost double that of its industry peer group. Analysts’ mean price target is $44.20, according to First Call data, suggesting the shares will be little changed.

Investors who have shorted the stock, seeking to profit on a decline, can’t make up their minds. The current short interest is at 7.6, half what it was about a month ago, just before it reported its second-quarter results.

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