This morning, lululemon (LULU) reported mixed earnings, with solid results but lowered guidance, as expected.
Earnings beat by $0.04 and revenues were in line. Gross margins were softer than expected, but operating margins were ahead of expectations. The clear highlight was the 3% same-store sales growth led by the 27% Internet direct-to-consumer (DTC) same-store sales growth, which offset the 3% decline in the bricks-and-mortar stores.
Interestingly, the reasons for lowering guidance were not demand-related. The reasons were negative impact from the West Port strike, strength in the Canadian dollar, and delays in one of the company's international store opening.
In fact, lululemon indicated that revenues would have been higher than expectations, had the West Port strike issues not been a factor. This is one of the reasons the stock is up 10% today. Another reason for the rise in stock price is that the CEO said: as the quarter progressed, business got stronger, and fourth-quarter trends to date are encouraging.
Remember, the third quarter will be the last quarter of the older product. It's not surprising that gross margins were pressured, as the company cleared inventory, getting ready for the new merchandise chief's new products. Finally, with 29% of the float shorting the stock, we are seeing some short covering on the news today.
Third-quarter revenues rose 10.4% year-over-year on 3% same-store sales growth, which was led by the 27% Internet growth. It was offset by the 3% drop in bricks- and-mortar, and against a very tough comparison of up 11% last year. Store growth also helped, with the addition of 42 net new stores since the third quarter of 2013. In the third quarter of 2014, the company opened 19 net new stores, 15 in the U.S., one in Canada and 3 ivivva brand stores. While bricks-and-mortar comps fell 3%, the company did note that traffic picked up from the second quarter. This is an encouraging sign, and an offset to lower conversion.
Direct-to-consumer (DTC) revenues increased to $77.2 million, or 18.4% of total company revenues, up from 16.3% last year. It is important to note that lululemon is seeing an inflection point in its women's business, which is huge news, after many quarters of disappointing results in this key segment. It means that the company hasn't lost its core customer, and as the new product gets into the stores, this certainly leaves room for building momentum further. Inventories also grew at a manageable 11% in the quarter, consistent with revenue growth expectations.
Gross margins came in at 50.3% and below the 51% consensus, on product mix (less seasonal merchandise, older lines), supply chain pressure, and deleverage offset. This offset was by a stronger operating margin at 19.4%, which was well ahead of the 18.2% consensus. The lower SG&A expense was also far better than expectations at 30.9% vs. 33%. Cash at the end of the quarter was at $633 million, and lululemon used some of its cash to buy back 1.8 million shares, at an average price of $40.49.
Guidance was lowered for the fourth quarter and 2014, primarily due to the West Coast Port delays, which will hurt results by $12 million. lululemon has already re- routed its lines to different locations. The stronger Canadian dollar and temporary delays at its second London store were other minor reductions.
We think the management team is being somewhat conservative on guidance. It is forecasting for gross margins to expand (with the help of a better product mix) at 51% to 52%, and the fourth-quarter revenue guidance is $585 million to $600 million. It sounds like the company is running at the high end of management's range.
Expectations had been fairly low this week, headed into the report, and the stock trades at a significant discount to its historical range (22x vs. 35x). We don't expect the stock to get back to the old levels. but we do believe there is room upward, as the new management executes. The stock should also benefit from the secular growth in athletic apparel, which is growing on an average of 9% per year vs. total apparel at just 2%. The competitive landscape is something to watch, but we see the market as big enough for many players. It is certainly big enough for LULU to play catch up in 2015.
Regards,
Jim Cramer, Stephanie Link, and TheStreet Research Team
DISCLOSURE: At the time of publication, Action Alerts PLUSwas long LULU.