Gross Margins and Inventory Will Be Key With Lululemon Earnings

By Trey Thoelcke Updated Jan 13, 11:28AM EST · Published Mar 28, 11:10AM EDT

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Gross Margins and Inventory Will Be Key With Lululemon Earnings — © Thinkstock

What has happened with Lululemon Athletica Inc. (NASDAQ: LULU) since December serves as one more instance of official analyst downgrades to be either ignored or even used as contrary indicators. It was back in early December when Susan Anderson at FBR downgraded the yoga clothing and apparel retailer to a target of $42 from $55. Since then, the stock is up 27% with good news continuing to flow in. One wonders how those who rate stocks in an official capacity actually make money unless they are not taking their own advice. One thing FBR got correct though, sort of, was the price target of $42. The low was hit at $43.14 two weeks before the call was ever made.

Back in December, Lululemon was suffering from a backup in inventory, a concerning problem for sure, and one that could have indicated a fundamental lack of demand for its products, or else minor balancing issues caused by unforeseen logistical problems. In this case it was the latter. Analysts were concerned with declining margins due to deep discounts the clothing retailer was forced to enact at the time. It had to because of problems at trading ports rather than a lack of demand for its products.

Lululemon is now dealing with those issues in a surgical manner rather than completely changing its business model, which makes sense given that this was a surgical problem and not a systemic business issue. The word “inventory” was mentioned 31 times in its most recent earnings call, and the company anticipates the problem to be fully dealt with, or nearly so, by the end of the first quarter.
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How is it dealing with the problem? First, expanding RFID technology to all its North American stores now allows it to match sales with inventory seamlessly. Some 8% of all higher-margin direct-to-consumer sales were due to the new system in the third quarter. Highly anticipated fourth-quarter earnings are scheduled for March 30, so we’ll see just how much the inventory issue is still extant. In fact, it may have ended up helping the company by forcing it to adopt better technologies sooner, enabling it to profit off of higher-margin e-commerce sales that are making up for lost margin during the troubled quarters. E-commerce was up 16% in the third quarter, and 21% excluding foreign exchange fluctuations. That means the all-important gross margin number looks likely to impress come March 30. The company has anticipated fourth-quarter gross margin at 49% to 50%, and that’s the number investors will be watching closely.

From a more long-term standpoint, Lululemon has no debt to speak of, which puts it in a very strong position relative to more leveraged competitors like Gap Inc. (NYSE: GPS). Despite the climb since August 2015, shares are still comfortably below 52-week highs, and even further below all-time highs. Any outperformance on gross margin or inventory metrics could easily be met with wide applause from Wall Street, sending shares higher through the summer.

About the Author Trey Thoelcke →

Trey has been an editor and author at 24/7 Wall St. for more than a decade, where he has published thousands of articles analyzing corporate earnings, dividend stocks, short interest, insider buying, private equity, and market trends. His comprehensive coverage spans the full spectrum of financial markets, from blue-chip stalwarts to emerging growth companies.

Beyond 24/7 Wall St., Trey has created and edited financial content for Benzinga and AOL's BloggingStocks, contributing additional hundreds of articles to the investment community. He previously oversaw the 24/7 Climate Insights site, managing editorial operations and content strategy, and currently oversees and creates content for My Investing News.

Trey's editorial expertise extends across multiple publishing environments. He served as production editor at Dearborn Financial Publishing and development editor at Kaplan, where he helped shape financial education materials. Earlier in his career, he worked as a writer-producer at SVE. His freelance editing portfolio includes work for prestigious clients such as Sage Publications, Rand McNally, the Institute for Supply Management, the American Library Association, Eggplant Literary Productions, and Spiegel.

Outside of financial journalism, Trey writes fiction and has been an active member of the writing community for years, overseeing a long-running critique group and moderating workshop sessions at regional conventions. He lives with his family in an old house in the Midwest.