Don't Stretch This Investment

 | Nov 15, 2013 | 2:00 PM EST  | Comments
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Stock quotes in this article:

lulu

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m

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gps

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ua

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nke

Shares of lululemon athletica (LULU) gapped down sharply as trading began on Thursday and continued to fall throughout the morning. They ended the day more than 4% lower after an analyst at Sterne, Agee & Leach cut the stock's rating to Underperform and issued a price target of $56. With a closing price of $66.18, the firm clearly sees the company as overvalued at current levels.

 

Source: TradeStation

 

Shares of this producer of athletic apparel and accessories were on the rise Wednesday morning following favorable comments and an upgrade from an analyst at JPMorgan Chase who suggested a target of $84 per share. With two very contradictory outlooks, investors are now left trying to discern which one carries the most weight.

As we search for the answer to this controversial question, let's look at the main concerns leading to the downgrade by Sterne, Agee, & Leech. Perhaps the most public concern rests on the quality of lululemon's products and concerns that the competition will be able to quickly make inroads into its marketplace.

Best known for its yoga apparel and sportswear, over the past year, lululemon has faced a series of setbacks. These included inventory recalls stemmed from consumer complaints regarding the sheerness of the fabrics used in their apparel and pilling when worn by many women.

Pilling occurs when, through everyday washing and wear, the fibers of a fabric start to create little bundles, called pills. They start with fuzz formation and then develop into little balls. These little tangles of fiber cause the clothing to look prematurely worn. Pilling happens to most fabrics over time, but some fabrics are more susceptible than others.

lululemon's chairman Chip Wilson recently came out with a statement aimed at addressing these complaints: He said "some women's bodies just don't actually work for (their pants)" and that over time women's thighs rubbing together will cause the pilling and poor performance of the product.

All I could say after reading this was, "Yikes!" If a chairman wanted to find a great way to alienate its customer base and tell them to go elsewhere, all it has to do is take its cues from Chip Wilson! This is precisely what Sterne, Agee & Leach suggest is happening. Some rather big names are among lululemon's competition: Nike (NKE), Under Armour (UA), Athleta and Adidas. And now, even The Gap (GPS) and Macy's (M) are tossing their hats into the ring. 

From a technical standpoint, lululemon also faces challenges in the months ahead. It has experienced remarkable returns in recent years, going from a low of $2.16 per share in early 2009 to a high of $82.50 in June of this year. The main thing that concerns me is the development of share prices at these highs.

While its highest high only recently occurred, lululemon had been trading at this zone of highs since early 2012. While it struck a new high this summer, it failed to follow through on the breakout, thus creating a bull trap above the 2012 high of $81.09. It then fell sharply to the lower end of this larger monthly trading channel heading into the third quarter and has been struggling to recover ever since.

 

Source: TradeStation

 

Unless momentum shifts on a daily and weekly time frame within this channel so that slower downside moves give way to more rapid upswings, JPMorgan's target of $84 seems unlikely to hit within the next 12 months. Instead, the charts suggest that Sterne, Agee & Leach's target of $56 is more attainable within that same time span.

In either case, one thing is for certain: This will remain a volatile stock in the months ahead. Therefore, it is perhaps best suited for the shorter-term market participant as opposed to longer-term investors.

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