The Daily Dose: Lessons from a Stock Crash

 | Jun 13, 2014 | 10:00 AM EDT  | Comments
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Stock quotes in this article:

lulu

,

nke

,

ua

Stock crashes have always freaked me out. It's so disturbing to watch a stock open down 15% and then close the session lower by an ugly 20%. Want to see the power of markets? Well, then, a stock crash reminds investors to not mail it in during the final moments of the research process. For all intents and purposes, shares of Lululemon (LULU) continue to crash -- which looks great from my perch, as we launched coverage on the name at a sell in March. But, for those continuing to be holders of Lululemon post-crash, or for those forced to toss in the towel during a stomach-turning session, the aftermath of the destruction could be tricky to navigate.

Do you buy more shares of Lululemon, as this is at long last the "weakness" in the stock that doesn't reflect the future potential of the business? Or, do you exit the position, log a few lessons learned, and vow to stay clear of Lululemon until earnings begin to topple consensus estimates via an upturn in same-store sales?

One thing you must keep in mind pertaining to a stock crash is that it's the market's way of saying: "There is a fundamental shift in market dynamics that are likely to hurt the company for at least the next six months. In the near-term, the company's financial statements will be hampered by these new market dynamics and by initiatives taken by the executive team to overcome them."

Here is how I would assess the carnage of Lululemon:

Net Sales

The core store sales for Lululemon continue to be under pressure, falling 4% in the most recent quarter. Not only are they negative at the stores, but the total, which includes online sales, isn't exactly showing material stabilization. Given Lululemon's new, higher cost locations, and unfavorable product mix, sales have to start to improve vs. weak year-earlier comparisons to counterbalance ongoing investments in product and supply chain. When that happens, and against tempered analyst expectations, Lululemon could set up for an earnings beat and in-line forward guidance. Yesterday, earnings beat, but there were material warnings for 2Q14 and FY14.

Marketplace

Why did Lululemon's expenses surge 20% in the quarter? The company is in investment mode to get its products back in high demand, to justify its public valuation. I believe it will be tougher than management thinks to reignite same-store sales. For instance, a new Nike (NKE) shop at a Dick's Sporting Goods represents a fundamental change that didn't exist when Lululemon's business and stock were on fire in 2007-2008. That new Nike shop -- alongside one from Under Armour (UA) -- is presenting cheaper alternatives to the consumer, who is more likely to walk into a Dick's for a piece of merchandise (think mom shopping for her kid's baseball team or a gift for Father's Day).

Realistically, Lululemon will have to consider opening shops in department stores, trading a portion of its store theater to reach new customers. These shops should be focused on upper-tier department stores such as Saks and Nordstrom, and also be extended to each company's web and mobile platforms. 

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