Yesterday morning on CNBC, Jim Cramer duked it out with Lululemon (LULU) founder Chip Wilson over the notion the company lost its way. I agree with Wilson. I think the stock will get chopped in half.
Jim made the case the company is doing a great job while Wilson was very critical of the current management team and the board of directors. I watched the discussion on my phone while I was at the dog park. I thought Wilson made some good points.
While the first quarter was strong, I think the second half of the year will be challenging. LULU reported that first-quarter fiscal 2016 revenue rose 17% to $495.5 million vs. the $487.8 million estimate. Earnings of $0.33 were $0.02 ahead of the consensus estimate.
On a currency-neutral basis, the company reported that total comparable-store sales rose 8%, but that was against an easy comp from last year when the company was hit by the West Coast Port strike. If you recall, when the port strike ended second-quarter comps jumped to 11%. There is no way LULU will do an 11% comp in July. In fact, most estimates are at half that number. And it doesn't get any easier.
In September of last year, the company introduced the pants wall. Previously, LULU organized the pants display by fit (or "sensation") instead of by silhouette. Customers were confused by the old display because pants were organized from tightest to loosest. Customers would end up buying pants that didn't fit. The new pants wall changed the categories to "hugged, naked, relaxed, tight and held in."
Hugged pants are good for exercise, while naked are designed to fit very tight, which makes them ideal for yoga. Relaxed pants are loose fitting and ideal for running errands. Tight are ideal for running and additional support. Held-in sucks it all in. And don't forget, LULU also had a big men's wear introduction last year where they will be lapping a tough comp in that department as well.
Wilson was trying to make the point the quarter wasn't as good as it seemed. I agree.
Retailers have made a sneaky change in the way they report same-store sales. Most now report something called total comparable sales, which is not the same as same store sales. Total comparable sales include the e-commerce business, which, in most cases, is growing much faster than in-store sales. You have to read to the end of the press release to find the old same-store sales figure.
So, same store sales actually grew just 3%, or 5% on a constant-currency basis, while direct to consumer (e-commerce) grew 17%, or 18% adjusted for currency. Add them all up and you get the 8% comp that analysts are crowing about.
If the headline number were 3%, the stock would have gotten hammered.
Investors loved the improved gross margin outlook. Management gave guidance that implied second-half margins would jump 120 basis points. But, again, that's a one-time event left over from the West Coast Port strike. Because of the strike, LULU used airfreight to get its merchandise to the stores, which wrecked margins. Now, the company is sending the stretchy pants on the boat instead of by plane and gross margins are bouncing higher.
While gross margins maybe coming back, because of higher operating expenses the company is actually experiencing SG&A deleveraging. In other words, LULU ended fiscal 2014 with a net operating margin of 15%. This year they will be lucky to get to a 12% net operating margin.
If you do the math, sales are expected to rise 12%, while expenses are expected to jump 17%. It's not supposed to work that way.
I think founder Chip Wilson was trying to say the closer you look, LULU has pretty poor earnings quality.
As I said earlier, I don't think the company will do a 9% comp in July nor will it do an 11% comp in the January quarter. Which means, if I'm right, the consensus estimates for Q3 and Q4 are way too high. In fact, estimates are so high, I think there's a good chance this stock will get cut in half.
Downward dog indeed!