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Why Lululemon Athletica’s Profitability and Margins Are Pressured

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Analyzing Lululemon Athletica’s costs and profitability in fiscal 2015

Lululemon Athletica (LULU) reported gross margins of 50.9% in fiscal 2015, down from 52.8% the previous year. Operating profit margins fell from 24.6% in fiscal 2014 to 20.9% in fiscal 2015. Major factors affecting last year’s lower margins included differences in the product mix sold during the year, higher transportation costs, and increased costs of manufacturing.

Profit margins also deleveraged due to the impact of the stronger US dollar versus the Canadian loonie (EWC) and the Australian (EWA) dollar. The company also experienced higher occupancy costs due to new store rollouts. The company opened 48 net new stores in the year, including 13 in 4Q14. Operating costs also increased due to higher investments in e-commerce and higher supply chain costs.

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West Coast port congestion

Last year’s profitability was also affected by slower flow of inventory to stores due to the West Coast standoff at multiple ports last year. Although the issue is now resolved, its impact is expected to continue in fiscal 2016 for LULU and other retailers, as shipments take time to unload.

Historical comparisons

LULU’s profitability in the last three years has been declining, and its gross profit margin has fallen from 56.9% in fiscal 2012, to 50.9% in fiscal 2015. The company’s results were affected by product issues and higher costs.

Despite these issues, LULU has historically been among the most profitable of its fellow sports apparel firms Under Armour (UA), Columbia Sportswear (COLM), VF Corporation (VFC), and Adidas (ADDYY). LULU’s margins and profitability are also higher than the S&P 500 Index (IVV) (SPY) and the overall consumer discretionary sector (XLY).

Gross margins also higher than other pure-play apparel players like The Gap (GPS) and L Brands (LB). The Gap and L Brands reported gross margins of 38.3% and 42.0% in their last fiscal years, respectively, compared with 50.9% for LULU.

Lululemon also beat sports gear giant Nike (NKE) in terms of its margins and return on assets (or ROA). However, Nike’s return on equity (or ROE) is higher.

Lululemon’s vertically integrated model helps the retailer (XRT) (RTH) and athleisurewear firm earn higher margins. Plus, LULU follows a scarcity-driven inventory model and deliberately keeps its apparel stocks low. This enables a faster sellout of inventory and results in lower discounting, helping its margins.

Please read Part 5 for more information on the company’s cost outlook.

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