Once-hot Canadian clothing retailer Lululemon Athletica inc. (NASDAQ:LULU) has endured a very rough ride over the past couple of years. Earlier this year, things became even worse with the now-infamous botched recall of its too-revealing yoga pants. Unfortunately for Lululemon Athletica inc. (NASDAQ:LULU)’s shareholders, the bad news continues to roll in: With the unexpected announcement that the company’s longstanding CEO would quit in the coming months, Lululemon’s stock took another dive into the basement. Meanwhile, the firm has announced plans to de-list its stock from the Toronto Stock Exchange and officially move all of its trading operations to the Nasdaq.
The company has tried to put the best possible face on these developments. Unfortunately, they have overshadowed a potentially positive step: After years of debate, Lululemon Athletica inc. (NASDAQ:LULU)’s management team has decided to open a number of retail outlets that focus exclusively on men’s clothing. Although it remains to be seen whether this effort will succeed or fail, it is encouraging to see that the company remains capable of big plans. However, it has a long road ahead of it, and investors should approach the stock with caution.
Lululemon, Adidas and Under Armour
Although it began as an upscale retailer in its home province, Vancouver-based Lululemon has become very popular in the United States, Oceania and certain other developed-world markets. As such, the company has come into conflict with recognizable purveyors of athletic clothing like Germany-based Adidas (NASDAQOTH:ADDYY) as well as high-end sports outfitters like Baltimore-based Under Armour Inc (NYSE:UA).
Lululemon Athletica inc. (NASDAQ:LULU) is similar in size to Under Armour Inc (NYSE:UA). Although its market capitalization has declined markedly in recent months, its $9.4 billion figure exceeds Under Armour’s $6.3 billion figure by a decent amount. Meanwhile, Adidas has a valuation of more than $23 billion. In 2012, Lululemon earned about $271 million on revenues of just over $1.4 billion. While this made for a tidy margin, it did not live up to the market’s high expectations. For comparison, Under Armour Inc (NYSE:UA) earned about $122 million on just under $2 billion in revenues. Adidas ran away with earnings of $705 million on revenues of $19 billion.
Lululemon and Under Armour lack significant amounts of long-term debt and seem to have adequate reserves of cash that are replenished by healthy cash flows. By contrast, more mature Adidas has a roughly even debt-to-cash ratio. Fortunately, its levered free cash flow figure of nearly $1 billion has kept its head above water. Lululemon Athletica inc. (NASDAQ:LULU)’s weakest link may be its valuation: At just over 10, its price-to-book ratio exceeds that of Under Armour by nearly 50 percent and comes in at triple that of Adidas.
CEO Steps Down
The announcement that longtime CEO Christine Day would step down overshadowed an otherwise solid earnings report from the company. Although the timing of the move was unexpected, it did not come as a complete surprise. Ms. Day had served the company for nearly six years and presided over an era of breakneck growth that was clearly coming to an end. She may have felt that this was a natural time to call it quits. However, Lululemon’s stock did not react well to the news that an iconic leader was hanging it up. Whether this news results in permanent damage to the company’s stock price and corporate image may depend on the selection of Ms. Day’s successor.
New Approach to Retailing?
Lululemon also announced that it would open several male-focused stores by the end of 2016. Although the details of the plan remain sketchy, it seems clear that this will require the release of several new clothing lines and could necessitate a re-branding that de-emphasizes the firm’s yoga-wear roots. Given the company’s appeal to active women, many observers believe that this will be difficult. Even if Lululemon Athletica inc. (NASDAQ:LULU) can execute a successful re-branding campaign along the lines of Nike’s (NKE) gender-neutral marketing operation, its ultimate success may depend on the whims of routine-oriented male athletes.
Finally, Lululemon has voluntarily de-listed itself from the Toronto Stock Exchange. While its Canadian listing made sense during the company’s early growth phase, its Nasdaq listing now handles the bulk of its share volume and provides tremendous liquidity for a company of its size. The ramifications of this decision are unclear, but it is possible that it will smooth out some of the day-to-day volatility for which Lululemon’s stock is notorious.
Invest or Stay Away?
Lululemon Athletica inc. (NASDAQ:LULU) excites passions among longs and shorts alike. Since convincing theses can be made for trades on all sides of this name, it is imperative that investors conduct their own due diligence. However, it is possible to make some generalizations about the firm that could influence investing decisions.
For starters, Lululemon remains overvalued relative to its peers. In light of the turmoil within its management ranks and recent product-quality issues, this could leave it vulnerable to bad news. Moreover, the company has issued some aggressive sales projections that may be difficult to reach over the next few years. The risky male-targeted expansion provides plenty of additional reasons to be cautious as well.
In sum, Lululemon Athletica inc. (NASDAQ:LULU) is a risky stock that could break in either direction. While its beaten-down shares and aggressive sales forecasts suggest that its current valuation could be warranted, it remains vulnerable to forces beyond its control. Investors who do wish to play the firm for a short-term bounce should use sensible hedges. Meanwhile, long investors may wish to offset their positions with options or other tools.
The article Where Are The Opportunities After The Big Changes at Lululemon? originally appeared on Fool.com and is written by Mike Thiessen.
Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica and Under Armour. The Motley Fool owns shares of Under Armour. Mike is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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