lululemon's Prospects Turn Sour

 | Jun 11, 2013 | 1:28 PM EDT
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lululemon athletica (LULU) makes this business real hard. Christine Day's resignation from lululemon makes it downright impossible. If you don't know Day, she's the CEO who built lululemon into a $10 billion powerhouse of apparel. Last night, inexplicably, she quit the firm, and anyone who follows the company is reeling from her decision. Hence, the stock is down 13 points from Monday's close.

First, it's never easy to own a company that sells at 40x earnings, even a company as strong as lululemon, a business which has gone from yoga cult apparel to mainstream sports clothing that's strong enough to challenge anyone, including Nike (NKE), in its category. For years now I have been hearing that lululemon has peaked, that its valuation is too stretched and that it's got serious competition, including Athletica, which is owned by Gap (GPS), and that Athletica can step on lululemon like you or I could step on an ant.

Yet the company has grown pretty much without skipping a beat. A few years ago, there was a challenge about whether lululemon was truly using algae-based products. The company was able to explain away whatever ridiculous issue that might have been, and the bears who had been gunning for it were steamrolled by some amazing comparable numbers soon after.

Several other times in candid moments, the company has said that inventories weren't in line, yet soon afterward, the company righted the inventories, and again, the bears were pulverized.

But the most serious assault against lululemon came from within, when the company produced pants for a key product line that weren't up to snuff. It was a highly visible, highly embarrassing slip, and once again, I read the premature obituary for a company that had been coming out of a retail funk with flying colors.

And then Christine Day stepped up and, in a moment worthy of when Johnson & Johnson (JNJ) pulled all Tylenol because of what turned out to be an isolated but horrendous serial killing by someone who inserted poison into some Tylenol bottles, she recalled all of the offending pants.

It was breathtaking. Initially, the company seemed to be coming apart, literally, at the seams. So of course the stock was crushed, plummeting from $71 to $62 in just a couple of days' time. How in heaven's name could lululemon the company or lululemon the stock ever climb out of this hole?

And that was when we realized the magic of Christine Day's response. Rather than allowing the crisis to sink the company, she actually used it to distinguish her company from all others in apparel, or in any consumer goods company for that matter. What she said with her recall of the most important and lucrative product line is that neither she nor lululemon cares about short-term earnings. She did not care about possible ridicule or, worse, a fallout that comes from angry consumers who now feel had and who didn't even know the difference. What she cared about was the preservation of the brand and everything lululemon stands for. She embraced the same standards that a pharmaceutical company with a damaged product would. Her actions struck a chord with her customers.

And lululemon turned a potential disaster into an event that demonstrated how much it valued its patrons. Oh, and the quarter turned out terrifically, as we found out with last night's earnings release.

That's why, when I read the news about Day's inexplicable departure and then heard her say on the call that "the timing's right to bring in a new person to lead," I felt as naked as women might have felt who were wearing lululemon's defective see-through pants.

The chief reason you stuck with this incredibly expensive stock was Day's amazing leadership. If you lose the steward, what do you have, other than a very expensive stock of a very expensive apparel purveyor? That's not good enough for me. It shouldn't be good enough for you. I am sure the stock can bounce after this pasting. But frankly, it's a bounce to sell, not buy, because in these kinds of situations, leadership is everything and this company just lost one of the truly outstanding leaders, not at the best possible moment, as Day claims, but at the worst possible moment, just when it was able to harness that loyalty that she engendered and take the company to a much higher level.



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