LULU: Bottom Line Has Changed

 | Mar 19, 2013 | 9:00 AM EDT  | Comments
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Stock quotes in this article:

lulu

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m

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dks

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urbn

Remember when transparency used to be a good thing? First, monthly sales disappeared and then Macy's (M), Dick's Sporting Goods (DKS), Urban Outfitters (URBN) and others stopped breaking out online sales. And now Lululemon Athletica (LULU) has a transparency problem of a different kind. 

On Monday, the premium priced yoga retailer announced its Luon women's bottoms have a transparency defect affecting 17% of the total inventory of its women's apparel bottoms. Translation: You don't need that kind of visibility while you are in a downward facing dog position.

The company announced comps were running 11% in the first quarter; however, due to the new product shortage, comps are expected to be closer to 5%-8%. Earnings-per-share (EPS) guidance will be issued on the regularly scheduled earnings call, which is set for Thursday.

While the product malfunction may be a short-term issue, the incident does raise the question of quality and trust. If the consumer starts questioning the quality aspect of the $80-plus exercise pants, will they seek out a cheaper alternative? Or worse, into the arms of competitor Athleta (who similarly priced pants run between $64 and $89)?

Just as we were heading into the fourth-quarter conference call a return to double-digit comps in the first quarter probably would have been met with a sigh of relief. Remember that last quarter LULU broke the streak of issuing guidance for double-digit comp increases (guidance was HSD). And, also as a reminder, the company did not raise the high single-digit comp expectation (raises also typical). Now, the focus on a return to double-digit growth has gone to the dogs.

The next focus for LULU will be damage control. How long will it take to get the product back in stock? More importantly, what damage has been done to the brand? Investors were already questioning how long LULU would be able to maintain its full-price stance when the rest of the retail world is resorting to promotions to drive sales. As a reminder: LULU told the Street in mid-January that less than 2% of its product was marked down pre-holiday. Yes, the LULU customer was still willing to pay full price and that means inventories should be in good shape at the end of the fourth quarter.

The question is what to do with the stock? I own LULU and am most enthusiastic about the European growth trajectory where there is little competition and a long runway. I will look to average down on the news. But for now, the focus will remain on damage control measures.

While the fourth quarter may be intact, the bottom line has changed. And we can see right through it.

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