lululemon athletica inc. (NASDAQ:LULU) has plunged by over 36% over the last six months, compared to a gain of over 42% by the Insider Monkey Billionaire Index.
LULU used to have something most apparel companies spend years trying to create: customers who were willing to pay premium prices because they genuinely wanted the brand. That made the company more than another athletic wear retailer. It had a strong product reputation, an engaged community, and enough pricing power to keep margins high.
That advantage is now being tested.
In the second quarter, Lululemon’s revenue fell 4% to $2.4 billion, while comparable sales declined 10%. North America was the biggest problem, with revenue down 8%, and management said the response to new products remained inconsistent. The problem is that customers are becoming less excited about Lululemon.
In May, we published an article about 9 stocks big short’s Michael Burry is betting on. LULU ranked fifth on that list. The #1 stock in that list returned roughly 30% since the article was published.
The product problem is bigger than leggings
Lululemon’s biggest warning sign may be its core women’s business. Leggings sales fell approximately 20% in Q2, even though the company remains the market leader in the category. Management says customers are increasingly looking for “away-from-body” silhouettes, meaning looser styles that are less form-fitting. New products such as Groove and updated Dance Studio styles are performing better, but they are not yet making up for the decline in leggings.
That tells us something important about the turnaround.
This is not mainly about getting people to visit stores again or spending more on advertising. Customers are already telling Lululemon what they want. They want newness and differentiation, while some of the company’s most established products are losing momentum. Management itself said consumer research points to demand for more innovative products and stronger community engagement.
The company is responding by cutting SKUs, chasing successful products more aggressively and shortening product lead times. It is chasing roughly 20% more volume this year than last year. Those are sensible changes, but fashion leaves little room for error. By the time a brand realizes a trend has shifted, the next collection may already be months away.
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The brand has become vulnerable
This is where competitors such as Alo Yoga and Vuori matter.
Lululemon’s problems have also become more visible over the past year. Complaints over its Get Low leggings added to concerns about product execution, while a prolonged fight between founder Chip Wilson, activists and the board increased pressure on management. The company eventually replaced Calvin McDonald with former Nike executive Heidi O’Neill, who became CEO in September.
Now O’Neill has inherited a business where the challenge is to make consumers want the product again.
Her timing is important. On October 7, Lululemon appointed former Nike executive Maggie Gauger as chief product officer, reinforcing just how central product development has become to the turnaround.
The international opportunity is still real
lululemon athletica inc. (NASDAQ:LULU) is not suddenly a broken global brand.
Revenue outside North America continued to grow in Q2, with rest-of-world revenue up 6% on a constant-currency basis. Japan remains one of its strongest markets, while management still sees significant room for expansion in China and other international markets.
That could ultimately become an important part of the recovery. But international expansion cannot fully compensate for a weaker North American brand. The U.S. and Canada are still where Lululemon has its deepest customer base and strongest economics.
So has Lululemon lost its mojo?
It is hard to say that yet. The brand still has a large and engaged customer base, international growth opportunities, and products that are working. But the company has lost something more important than a few percentage points of sales: confidence that it knows exactly what its customer wants next.
That is why the next product cycle matters so much. If Lululemon can turn the current shift in consumer preferences into another successful wave of products, the recent weakness could look like a difficult transition. If it cannot, Alo, Vuori, and others may continue taking pieces of the market.
The valuation changes the risk-reward
At 10.74x forward earnings, Lululemon is now trading below the peer average of roughly 15.8x. That discount is interesting because Lululemon is still a much more profitable business than many apparel companies. Yet, it could be a value trap unless the company can somehow bring back interest in North America.
Lululemon is a perfect example of why it’s risky to buy an expensive stock. A few years ago, it was trading at mid-forties times earnings. Despite the fact that the business continued to grow, the growth didn’t meet expectations, which caused the stock to plummet. At current levels, though, while earnings growth is less attractive, the reasonable valuation makes the stock worth a look.
Conclusion
Lululemon has not lost its brand overnight, but it has lost some of the product momentum that made the brand so powerful. The new CEO can help, but the real test is whether Lululemon can once again create products customers actively want rather than simply market the products it already has.
At 10.74x forward earnings, the stock is certainly cheaper than it used to be and cheaper than its peers, despite being profitable.
Hedge fund sentiment toward Lululemon weakened in the second quarter. According to Insider Monkey’s database, 51 hedge funds held Lululemon in Q2, down from 61 funds in Q1, while the value of their positions fell from $1.14 billion to $611.94 million.
While we acknowledge the risk and potential of LULU as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than LULU and that has 10,000% upside potential, check out our report about this cheapest AI stock.
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This article is originally published at Insider Monkey.
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