LULU: Caught With Its Pants Down

 | Mar 19, 2013 | 9:03 AM EDT  | Comments
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After the close Monday, lululemon athletica (LULU) cut guidance after disclosing a major manufacturing defect in some of its women's yoga pants would cause them to be too revealing. While everyone had a good laugh over the "level of sheerness" comments in the press release, I was more interested in the company's guidance. Should the stock sell off in a meaningful way, this could be a great opportunity to get into the shares of a terrific company.

Management said that had pants not been defective, the company would have reported an 11% increase in same-store sales. But because of the defective merchandise, same-store sales would likely be reduced to a 5% to 8% increase. Management reduced first-quarter guidance from an expected range of $350 million to $355 million to a range of $333million to $343 million. At the midpoint of guidance, it works out to about $14 million to $16 million in lost sales. While it may take a quarter or two for the company to restock its selection, the reality is a $15 million hit is only 1% of the company's estimated annual revenue of $1.37 billion.

Even if the pants shortage lingers for a few quarters, it's hardly a disaster. LULU's next earnings report is before the market open on March 21 and I expect management to provide more color on the extent of the manufacturing problems. If it's a relativity small problem, you have a great opportunity to get into a terrific retailer.

With Monday's announcement, shares tumbled almost 8% in premarket trading to $65.90. That's like a $950 million reduction in the company's market cap because of a problem that's about 1% of its business. LULU would be a good buy if the stock fell below $65. Problem is, many other people are thinking the same way and it would be unlikely for the shares to collapse down into the mid $50s (where it would be a good buy).

It's hard to find a retailer that reports same-store sales in double digits, has a fanatical fan base and isn't being knocked off by less expensive brands or the Internet. Given LULU's fan base, I expect the company to make the lost sales up in the back half of the year, anyway. While sheer yoga pants are an embarrassment, this downward dog should be moving higher soon enough.

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