I Predicted That Lululemon Stock Was In Trouble Ahead of Earnings. What's Next After Its 17% Drop?

Ahead of Lululemon's (NASDAQ: LULU) fiscal Q2 earnings report, I wrote an article published on Aug. 26 that said the stock looked like a value trap and that the warning from Dick's Sporting Goods would likely spill over and impact it as well. The stock subsequently plunged 17% on Sept. 4, in the session following its earnings report, as the athleisure company reported disappointing results and cut its full-year outlook. The stock has now lost more than half its value this year and nearly three-quarters of its value over the past five years.

Let's dive into the yoga brand's latest results and prospects to see what could come next for the once-high-flying apparel stock.

Troubles continue

Unfortunately for Lululemon, cutting guidance has become commonplace. For the fourth time since last June, it slashed its full-year outlook. It now expects revenue to decline by 7% to 5% to between $10.35 billion and $10.5 billion, down from prior expectations for sales in a range of $11 billion to $11.15 billion. Full-year adjusted EPS is projected to be between $9.48 and $9.73, but that includes a $0.86 tariff refund. Earlier, it guided to adjusted EPS of $10.95 to $11.15 without a tariff refund.

The company's Q2 results were pretty dreadful, and it looks like things are only worsening. Management noted everything from negative social media commentary to weak responses to new product launches to increased competition and brand deterioration.

Overall, the company's Q2 revenue fell 4% year over year to $2.42 billion, missing the $2.46 billion consensus estimate. Adjusted earnings per share (EPS) plunged 34% to $2.01, but were above the $1.79 consensus.

The underlying numbers were even worse. Americas revenue sank 8%, while same-store sales plunged 12%. International revenue rose 4%, but only 2% in constant currencies, while comparable sales in constant currencies slipped 6%.

China had long been a bright spot for Lululemon, but revenue fell 2% in constant currencies while same-store sales dropped 8% excluding foreign currency movements. The company said it was impacted by negative brand sentiment, which shouldn't be surprising given its big PR gaffe in China when, at an important yoga event held on the Great Wall, it inadvertently gave a Chinese actor a Japanese taiko drum to play instead of a Chinese dagu drum. Rest-of-world sales rose 6% in constant currencies, but comparable-store sales on the same basis dropped 6%.

Gross margin decreased by 200 basis points to 60.5%, but it would have been down 360 basis points when excluding the tariff refund.

Inventory was basically flat year over year, and it is doing a decent job of keeping this in check. This is an important metric to monitor for struggling brands, as big increases above sales growth can lead to more markdowns and sales.

Looking ahead, things will start getting worse for the company just as its new CEO takes over. While it is not uncommon to set a low bar when a new CEO or CFO comes on board, the company still projected a pretty meaningful sales decline. It expects Q3 revenue to decline by 10% to 11% to between $2.290 billion and $2.320 billion. Adjusted EPS is expected to fall to between $0.93 and $0.98 for the quarter, versus $2.59 a year ago.

Image source: The Motley Fool

Is the stock a buy on the dip?

While Lululemon stock looks cheap, now trading at a forward price-to-earnings (P/E) ratio of around 9 times this year's and next year's analyst estimates, the stock looks like it is set to fall into the same trap as other once very popular athletic apparel brands like Nike and Under Armour. The brand has lost its luster and faces increased competition, and, quite frankly, from my viewpoint, the athleisure fashion trend is shifting. I was recently eating lunch at Panera, and nearly everyone was wearing jeans. That is not something you would have seen a few years ago.

As such, this is a stock I'd still stay far away from, and it will likely take at least several years for a potential turnaround.

Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nike. The Motley Fool recommends Lululemon Athletica Inc. and Under Armour. The Motley Fool has a disclosure policy.