Image Source: Lululemon Athletica Inc – Fourth Quarter of Fiscal 2019 Earnings Infographic
By Callum Turcan
On March 26, Lululemon Athletica Inc (LULU) reported fourth quarter and full-year earnings for fiscal 2019 (period ended February 2, 2020) that had some bright spots, though shares of LULU initially traded down on March 27. While the company beat on both the top- and bottom-lines, investors are growing increasingly worried about the performance of discretionary consumer goods companies in the face of the ongoing novel coronavirus (‘COVID-19’) pandemic. In fiscal 2019, Lululemon’s GAAP revenues rose 21% year-over-year and its GAAP gross margin climbed by ~65 basis points, with its financial performance supported by rising direct-to-consumer sales (up 35% year-over-year) which tend to command higher gross margins. Adjusted comparable sales rose by 9% year-over-year in fiscal 2019 (keeping in mind there was an extra week of sales in fiscal 2018), a growth rate that rises to 10% on a constant-currency basis.
Contending with COVID-19
While usually such strong performance would win plaudits from the market, please note these are extraordinary times. Lululemon had this to say within its earnings press release (emphasis added):
The outbreak of the COVID-19 coronavirus has been declared a pandemic by the World Health Organization and continues to spread in the United States, Canada, and in many other countries globally. Subsequent to February 2, 2020, in line with recommendations by public health officials and in accordance with governmental authority orders, we have taken actions to close certain retail locations and to reduce operating hours. We continue to monitor the situation and work closely with local authorities to prioritize the safety of our people and guests.
In February 2020, we temporarily closed all of our retail locations in Mainland China. All but one of these locations have since reopened. In March 2020, we temporarily closed all of our retail locations in North America, Europe, Malaysia, New Zealand, and we temporarily closed our distribution center in Sumner, WA. These locations currently remain closed.
Furthermore, the company declined to provide guidance for fiscal 2020, noting that:
Due to the impact that COVID-19 is having across the globe, and the rapid and continuous developments, we are not providing guidance for fiscal 2020 at this time. We will provide additional updates as the situation warrants.
Digital Sales Could Provide Some Relief
These are reasonable measures that Lululemon has taken, and there’s not much a consumer discretionary company can do given the circumstances. We want to stress that the one source of strength for Lululemon comes down to its growing direct-to-consumer business as households are increasingly turning to e-commerce sales channels to maintain social distancing habits while still being able to purchase goods. Nike Inc (NKE) has had tremendous success of late with its digitally-oriented direct-to-consumer Nike Direct operation, which we covered in this article here, and should Lululemon successfully shift significant resources towards supporting that offering (if possible, given the shutdown at its operations stemming from COVID-19 containment strategies), there’s room for the firm to generate incremental sales while the global economy is on lockdown. Here’s some commentary from Lululemon’s management team during the firm’s latest quarterly conference call:
“Our key e-commerce DCs [this appears to reference distribution centers] continue to function, we are practicing social distancing, monitoring the health and well-being of our people closely and taking precautions to maintain our operations.” — Calvin McDonald, CEO of Lululemon
—–
“Our DCs are up and running with exception of our facility in Sumner, Washington, which has been close in line with temporary local restrictions. This DC does not fulfill the significant number of e-commerce orders and the closure has not had a material impact on our business…
…our digital business has remained strong throughout driven by traffic and improving conversion that is a direct result of the investments we have made in our digital platform. The strength of our business early in Q1 both in-store and online reinforces that our brand remains strong. That said we did see a dramatic slowdown in our business in conjunction with our store closure and we expect this to have a negative impact on Q1 comps margins and EPS.” — Patrick Guido, CFO of Lululemon
While Lululemon’s physical store closures will have a large negative impact on its financial and operational performance going forward, as expected, its digitally-oriented direct-to-consumer operations seem to be holding up relatively well with management communicating that the firm’s distribution centers (save for the facility in Sumner, Washington) are still operational. Please note that this could change at any time given the volatile and fast spreading nature of this pandemic.
Financial Update
At the end of fiscal 2019, Lululemon was sitting on $1.1 billion in cash and cash equivalents and no outstanding debt, which we can really appreciate. Lululemon’s pristine balance sheet will be a major source of strength during these harrowing times. Its current ratio came in at over 2.9x at the end of fiscal 2019. The firm noted it had some flexibility over its future inventory purchases to maintain its working capital position. Additionally, the company has an untapped $0.4 billion revolving credit line (according to management’s commentary) which supports Lululemon’s access to liquidity.
While Lululemon’s store count grew from 440 at the start of the first quarter of fiscal 2019 to 491 by the end of the fourth quarter of fiscal 2019, which has increased its fixed costs, the firm maintains the financial firepower to cover those expenditures and can emerge on the other side of this ongoing pandemic. As we’ve said many times in the past, (net) cash is king.
In China, the nation to first report cases of COVID-19, which responded by shutting down most/all economic activity in various regions, Lululemon’s sales have started to bounce back as most of its stores in the country have since been reopened. Management mentioned during Lululemon’s latest quarterly conference call that:
“…[W]e are confident in our abilities to navigate the near-term while working to realize the opportunities over the longer term. In addition, we have early learnings from China which show us that our business will bounce back. We are not yet back to pre-closing volumes, but the business is getting stronger week by week.” — Calvin McDonald, CEO
While Lululemon’s performance elsewhere will come under immense pressure over the coming weeks and months, there could be some relief coming from its Chinese operations as economic activity resumes (keeping in mind China’s shutdown will still be reflected in its first quarter of fiscal 2020 results).
Concluding Thoughts
Lululemon is better positioned than most to ride out the ongoing pandemic, but there’s a lot of uncertainty concerning when the global economy will “reopen for business” so to speak. Its pristine balance sheet and Lululemon’s ability to lean on a combination of online sales and a restart of China’s economy helps power the light at the end of the tunnel, but no one knows for sure how long this tunnel is. We hope everyone and their loved ones stay safe out there.
Luxury Goods (Established Brands Industry – EL LULU NKE PVH REV SIG UA UAA VFC
Related: FXI, MCHI, BABA, TCEHY, IYK, XLY
—-
Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free.
Callum Turcan does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.