Lululemon Shares Fall More Than 5% As Credit Suisse Downgrades Stock

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Stock market darling Lululemon Athletica Inc. (TSX:LLL) saw its shares fall 4.6 per cent Friday after an influential firm downgraded the stock in anticipation of slower growth ahead.

Shares in the yoga wear retailer closed down $3.38 at $70.88 amid a report from Credit Suisse that downgraded Lululemon's rating to "neutral" from sector "outperform," citing a likely slowdown in comparative sales momentum and the risk of further merchandise margin pressure.

Lululemon has been a favourite of many investors as it consistently boosted quarterly profits and revenues in an otherwise struggling retail industry.

However, the company warned last month that it expects slower sales growth in the high single digits from the fourth quarter of 2012, down from 18 per cent comparable-store sales growth in the third quarter.

Credit Suisse expects further slowing in 2013, especially at its "mature" stores in Canada, which comprise 59 per cent of the athletic wear chain's total sales and have already seen a slowdown in growth.

"With this recent deceleration, our prior thesis for sustained double digit comps is at risk, as it was predicated on mature stores comping high single digits," Credit Suisse analyst Christian Buss said in the report.

He also cites the potential for Lululemon to have to increase discounting both in stores and online — a shift in strategy for the retailer that operated on a scarcity model in which it preferred to have customers chase inventory than stock too much.

The company began an initiative in late 2011 to boost its inventories to meet the growing demand of shoppers and appease those who were confident the company could grow faster. The challenge has been for Lululemon to reach a fine balance between having too much inventory on shelves and having too little.

"New and winter product lines appear to have stretched outside of the company's comfort zone, with re-pricing actions, broader discounting, and higher markdown levels than we have historically seen. This adds risk to Lulu's margin profile, but also suggests challenges to driving incremental sales with new designs and product extensions (particularly in more mature markets)," Buss said.

So far, Buss added, the retailer has successfully set itself apart from competition with its focus on brand loyalty and positioning its clothing as luxury sportswear, as well as its appeal across various sporting activities. But he believes competitors will begin to hone in on its market at lower price points.

"We see long-term risks to its competitive positioning and pricing power as activewear gains shelf space across retail channels (particularly premium department stores) and competitive vendors adjust offerings to compete with Lululemon at lower price points."

Late last year, Lululemon settled a patent infringement case against Calvin Klein and its manufacturer that claimed they copied a specific overlapping style of waistband. Terms of the deal were not disclosed, but Lululemon said the lawsuit will be dismissed as a result.

The retailer filed design patents for its Astro line of pants as early as September 2011, but filed patents on its crop pants much more recently, in June. Lululemon had claimed Calvin Klein sold pants under its "Performance'' brand that included the same waistband design elements and pant style, which is covered by its patents.

Lululemon opened its first store in 1998 in Vancouver and has expanded to 151 stores in the past decade.

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