The Gap Inc. (GPS), Ralph Lauren Corp (RL): Lululemon Athletica inc. (LULU) Is Far From Being A Lemon

On Thursday, Lululemon Athletica inc. (NASDAQ:LULU) reported mixed fourth-quarter and full fiscal year 2012 results. Although the specialty retailer was able to deliver 16% comparable store growth (year-over-year), the earnings release was clouded by the company’s recent recall of its black yoga pants due to the material being too sheer. This ultimately prompted some analysts to downgrade the stock due to this apparent weakness in the company’s ability to control its supply chain/quality control. Though this error on behalf of Lululemon has the ability to tarnish its brand in the eyes of some, and will cost the company up to $17 million, this is not the time to completely abandon the retailer. This is still a disciplined and highly profitable retailer that has shown a clear ability to grow its operation and provide a unique shopping experience to customers. The company’s full year highlights are as follows:

Net revenue for the fiscal year increased 37%.

Comparable stores sales for fiscal 2012 increased by 16% on a constant dollar basis, resulting in $2,058 annual sales per square foot for comparable stores for fiscal 2012.

Gross profit for fiscal 2012 increased by 34% to $762.8 million, from $569.4 million in fiscal 2011.

Income from operations increased by 31% to $376.4 million, from $287.0 million in fiscal 2011.

Diluted earnings per share in fiscal 2012 increased 46% to $1.85 on net income of $270.6 million, compared to diluted earnings per share of $1.27 on net income of $184.1 million in fiscal 2011.

These results illustrate the success Lululemon Athletica inc. (NASDAQ:LULU) has had building customer loyalty, while simultaneously driving both revenue and earnings in tandem. Although it’s now time for investors to look toward the company’s fiscal year 2013, it’s important to keep these results in focus as they illustrate Lululemon’s potential.

Looking toward 2013

Although Lululemon Athletica inc. (NASDAQ:LULU) cut its first quarter and full year outlook, in large part due to the yoga pants recall, the company is still projecting strong results as a result of the company’s long-term strategy. In the first quarter of 2013, the company expects comparable store sales to increase between 5% and 8% (down from 11%), and diluted earnings per share between $0.28 and $0.30 (down from FY12 first quarter results of $0.32). These declines and Lululemon’s misstep in not controlling the quality of one of its most popular items is nothing to scoff at, but it’s ultimately not time to call the retailer a “lemon.” Lululemon has been successful because of its incredible ability to break the conventions of retail and truly cater to its customers in a local fashion. Through operating stores in a manner that levies substantive power to the store manager, its stores operate to best serve the neighborhood or city at hand. This has resulted in higher-than-average comparable store growth, profitability and customer loyalty/retention. This strategy places Lululemon in a strong position to bring its successes in America to Asia and Europe. This future growth potential — that lies beyond the misstep within its yoga pants line — illustrates the long-term strength of Lululemon.

Getting down to numbers

The single largest concern investors have regarding Lululemon Athletica inc. (NASDAQ:LULU) is its valuation. Because the retailer is, in many ways, unlike any other, it’s difficult to draw a precise comparison. A company like The Gap Inc. (NYSE:GPS) is far larger and has seen its days of rapid expansion come and go. Though the company reported strong earnings last month, its profit margins (as seen below) don’t compare to Lululemon’s and its company structure is far more traditional. Another company that can very loosely fall into the stratosphere of Lululemon is Ralph Lauren Corp (NYSE:RL) due to its loyal following and appeal to a more affluent audience. Though this is true, Lululemon outperforms in terms of profitability and operates a very different business model. From a valuation perspective, here is how these three retailers compare:

Forward Price/Earnings: 24.79

Gap: 12.19

Ralph Lauren: 18.03

PEG Ratio: 1.25

Gap: 1.45

Ralph Lauren: 1.54

Profit Margin: 18.68%

Gap: 7.25

Ralph Lauren: 10.36

Short % of Float: 29.10%

Gap: 3.40%

Ralph Lauren: 2.80%

These metrics illustrate that, although Lululemon Athletica inc. (NASDAQ:LULU)’s forward price/earnings is higher than both Gap and Ralph Lauren, its PEG ratio is lower. This points to the aforementioned growth potential of Lululemon. Additionally, Lululemon’s profitability is substantively higher than The Gap Inc. (NYSE:GPS) and Ralph Lauren Corp (NYSE:RL). The other interesting and important metric is the short percent of float. Though in the short-term this poses the potential for large fluxuations in the market capitalization of Lululemon, if you believe in the scalability of Lululemon’s business model, in the long-term this could result in the stock increasing dramatically due to short sellers needing to cover. For investors, this points to a stock that could fluctuate substantially in the short-term, but has a long-term growth strategy that is still viable and exciting.

Conclusion

Though Lululemon Athletica inc. (NASDAQ:LULU) faces the burden of a substantial company-wide recall, its core value still remains. Investors should be cautious in the short-term due to the immediate uncertainty of how much the recall with cost and what effect it will have on the brand. The future of Lululemon is bright due to its growth potential and apparent ability to operate efficiently and highly profitably. Though the short-term may be rocky, there are few companies Lululemon can be compared to from a retail operations, profitability and customer loyalty perspective.

The article Lululemon Is Far From Being A Lemon originally appeared on Fool.com and is written by Justin Weinstein.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.