Fraying Lululemon margins disappoint, shares slump 12 percent

By Solarina Ho

(Reuters) - Shares of Canadian yogawear retailer Lululemon Athletica Inc (NasdaqGS:LULU - News) tumbled on Thursday as results showed margins had narrowed due to higher costs, even as it reported consensus-beating sales and modestly raised its full-year forecasts.

Shares in the Vancouver-based company dived 12.5 percent to $56.04 by late morning. They had initially risen modestly in premarket trading on the raised forecasts and topline results before concerns over the dwindling margins set in.

"You've got inventories that are bloated. You've got margins that are collapsing. And the explanation to all that is less clear," said Canaccord Genuity analyst Camilo Lyon.

"What that leads into is now a disbelief in their ability to recapture the margin levels that they've talked about."

During a conference call with analysts, executives said Lululemon's supply chain was finally running on time or early, but warned that inventories would remain elevated when combined with late product flows from the first half of the year.

Executives also noted that expenses relating to its international expansion efforts, leases, renovations, higher freight costs, and weaker currencies in Canada and Australia - two of its biggest markets - dragged on margins. But they reiterated their expectations for improvement next year.

Gross margin, or revenue less the cost of goods sold, was a softer-than-expected 46.8 percent, down from 50.5 percent a year ago. Lululemon said it expects a third-quarter gross margin of around 47 percent as those hurdles remained.

Chief Executive Laurent Potdevin told analysts on the call that higher markdowns and quality issues were not a problem, but analyst Lyon noted the company will be holding its third consecutive warehouse sale.

"I don't think they've ever done that in the past," he said.

Total comparable store sales rose 11 percent on a constant dollar basis in the second quarter.

The company raised its earnings forecast for the current fiscal year modestly to $1.87-$1.92 per share from $1.86-$1.91 and its revenue forecast to $2.03 billion-$2.06 billion from $2.0 billion-$2.05 billion.

Analysts, on average, expect a profit of $1.93 per share on revenue of $2.03 billion, according to Thomson Reuters I/B/E/S.

Lululemon's net income fell to $47.7 million in the quarter ended Aug. 2 from $48.8 million a year earlier. Earnings per share, however, rose to 34 cents from 33 cents as there were fewer shares outstanding.

Revenue grew about 16 percent to $453 million.

Analysts on average had expected earnings of 33 cents per share on revenue of $445.8 million.

(Additional reporting by Euan Rocha in Toronto and Amrutha Gayathri in Bengaluru; Editing by Kirti Pandey and Bernadette Baum)