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lululemon (LULU) Gains from Initiatives Despite Supply Woes

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lululemon athletica inc. (LULU - Free Report) has shown resilience in a tough market, which is plagued with industry-wide supply-chain challenges. The company has been benefiting from the robust response for its products, store productivity and continued digital momentum. Its robust business fundamentals combined with strong brand positioning in the athletic apparel space have also been drivers. These have resulted in the robust top and bottom-line trends for the company.

However, lululemon has been witnessing supply-chain challenges, driven by the pandemic-led factory closures, congestion at ports and reduced airfreight capacity, which are likely to impact its business in the second half of fiscal 2021. It also continues to witness higher SG&A expenses.

Factors Supporting Growth

lululemon’s business momentum can be attributed to the revival of brick-and-mortar stores, driven by improved footfall, as well as the continued expansion in the e-commerce channel. Top-line growth continues to reflect strength across all categories, channels and geographies. The company is witnessing a rebound in brick-and-mortar sales, driven by an increase in-store traffic as consumers returned to stores for shopping.

In second-quarter fiscal 2021, revenues at company-operated stores advanced 142% year over year and 9% on a 2-year CARG basis to $695.1 million. It continued to witness strong traffic trends, which increased more than 150% from the last year. Management pointed out that in-store productivity was in line with the comparable fiscal 2019 levels and reflected an improvement from 88% productivity in first-quarter fiscal 2021. As the COVID-led restrictions ease, lululemon had 95% of its stores open across the globe at the end of the fiscal second quarter.

The company continues to remain focused on investments to enhance the in-store experience. It is leveraging its stores to facilitate omni-channel capabilities, including the buy online pick up in store and ship from store. It has implemented several strategies to improve the guest experience and reduce wait time. These include virtual waitlists, mobile POS and appointment shopping. The services enable reducing the time of waiting in line to enter the store as well as allow customers to complete some transactions like returns, exchanges and purchase of gift cards without entering the store.

The company expects to capture the growing online demand and ensure a robust shopping experience through its accelerated e-commerce investments this year. It has been investing in developing sites, building transactional omni functionality and increasing fulfillment capabilities. The company continues to strengthen omni-channel capabilities such as curbside pickups, same-day deliveries and buy online pick up in store service. It is enhancing features like search, browse, checkout, personalization and payment methods across online platforms. The company plans to boost online category offerings and creative content.

Its five-year Power of Three plan also bodes well. The company earlier anticipated delivering sales growth in the low-teens in the next five years (ending 2023) through the execution of this plan. It also expects some annual benefits of this plan, which include modest gross margin improvement, a slight reduction in SG&A costs, operating growth in excess of sales growth, earnings per share growth equal to or more than operating income growth, and capital expenditure of 6-8% of sales.

lululemon provided expectations for the third quarter and raised its view for fiscal 2021. Management noted that its strong business momentum continued in the second half of fiscal 2021. Despite the headwinds related to COVID-19, including supply-chain disruptions, the company raised its guidance for fiscal 2021. Its financial position also keeps it on track to exceed targets under its Power of Three growth strategy.

For third-quarter fiscal 2021, the company expects net sales of $1.4-$1.43 billion, indicating two-year CAGR growth of 24-25%. Adjusted earnings are anticipated to be $1.33-$1.38 per share, whereas it reported $1.16 in the prior-year quarter and 96 cents in third-quarter fiscal 2019.

For fiscal 2021, the company expects net revenues of $6.19-$6.26 billion compared with $5.83-$5.91 billion stated earlier. The sales guidance implies a 2-year CAGR of 25%, which is higher than the 3-year CARG of 19%, leading up to 2020 and is significantly ahead of the low-teens CAGR targeted in the Power of Three growth plan. The fiscal 2021 sales view assumes phased reopening of the factories used for sourcing products in Vietnam in mid-September. Adjusted earnings per share are expected to be $7.38-$7.48 compared with $6.73-$6.86 mentioned earlier. This includes a modest dilution of 3-5% related to the MIRROR acquisition.

Near-Term Hurdles

The company’s near-term outlook is mainly hampered by the ongoing supply-chain headwinds and the factory closures in some regions. These headwinds have also hurt the performance of biggies like NIKE (NKE - Free Report) , PVH Corp (PVH - Free Report) and Ralph Lauren (RL - Free Report) in recent months.

On its last reported quarter’s earnings call, management noted that some of the Vietnam factories, which used to source lululemon’s products, have closed due to another wave of COVID-19 outbreak. This has delayed deliveries of products in recent months. The factors impacted the company’s margins to some extent in second-quarter fiscal 2021.

The company also continues to face headwinds related to capacity constraints and supply-chain challenges at ports and reduced air freight capacity. On a 2-year CAGR basis, inventory grew 26%. The company continues to anticipate further delayed inventory receipts, owing to issues related to port congestions and COVID impacts in some regions.

At the end of third-quarter fiscal 2021, lululemon expects inventory levels to increase 15-20% from that reported in third-quarter fiscal 2020. The company is witnessing some delayed inventory receipts due to congestion at ports and the recent COVID-related closures of certain factories in Southern Vietnam. While the expected inventory level is enough to support its revenue projection, it is lower than the initially targeted levels due to supply-chain challenges.

The company’s gross margin guidance for third-quarter fiscal 2021 includes a 200-bps impact of higher airfreight costs, owing to port congestions and capacity constraints. The gross margin view for fiscal 2021 includes an estimated 150-200-bps negative impact of additional freight costs compared with a 50-bps impact mentioned earlier.

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