Even the most patient investor in lululemon athletica (Nasdaq:LULU) has to be dreading earnings release dates from this fast-growing athletic apparel company. Not only does this stock experience the normal volatility that goes with high-growth/high-expectation names (“You missed comps by a half-point? Off with your head!”), but the announcement of a major product defect (see-through pants) and now the CEO resignation have added even more turmoil.

Through all of this, lululemon has remained an impressive growth story, but maybe the cracks are starting to appear and competitors are starting to up their games as well. While I'm solidly on board with the idea of picking up growth stocks on pullbacks that don't seem related to material events, the loss of a quality CEO seems pretty material to me. Consequently, I'd be careful about piling into lululemon with the idea that a quick rebound is guaranteed.

SEE: Why A Falling Stock Is Not Always A Bargain

Solid Operating Results, For Those Who Notice|
The resignation of CEO Christine Day is absolutely the biggest takeaway from Monday's news, but the underlying earnings for the company aren't exactly trivial either.

Revenue rose 21% as reported, with 18% growth in the retail business on top of 7% comp store growth (or 6% growth in constant currency). While those results were good for a slight beat, I would take note of the 4% decline in sales per square foot – maybe it's just a byproduct of the Luon pants issue (and LULU's sales per square foot are still excellent on a peer/industry comparison), but it's worth watching. At the same time, the 42% growth in direct-to-consumer sales was a very encouraging number.

Margins are suffering some from the pants recall, but not really any worse than expected. Gross margin was down more than five points as reported, but net merchandise margins (excluding the costs tied to the pants) were down just 90bp. Operating income was down 10% and the operating margin fell six and a half points, but lululemon nevertheless reported a two-cent operating beat (half from revenue and half from gross margin).

Ambitious Targets For The Next CEO
I honestly don't know what to make of the resignation of Christine Day. I certainly hope this was not a walk-the-plank situation tied to the Luon pants issue, as that would strike as an extreme overreaction. I also don't know if it's fair to interpret this move as a sign that Ms. Day believes the company has gone about as far as it can and wants to leave while there's still some luster to the company.

What I hope, but certainly do not know as fact, is that Ms. Day is simply looking for a new challenge. It's not uncommon for executives to prefer to run companies at particular stages of their life cycle – starting a new business presents a different set of challenges from managing the initial growth phase, and managing that growth into the next phase is yet another different set of challenges and opportunities. I don't think there would be much debate that lululemon is in a transition period between that initial “hyper-growth” and a new phase that includes expanding the product assortment and geographical footprint. At a minimum, I would expect lululemon to have a wide choice of eager CEO candidates to take over the job.

Still, this won't be an easy job to walk into for the next CEO. Management has laid out gross margin and operating margin targets (55% and 25%, respectively) that will be challenging in the near-term. What's more, customer surveys would seem to suggest that companies like Under Armour (NYSE:UA) and Nike (NYSE:NKE) have significantly stepped up their game, even if a survey published by Cowen tagged Gap's (NYSE:GPS) Athleta brand with kiss-of-death labels like “frumpy”, “unsexy”, and “middle class”.

SEE: Is Growth Always A Good Thing?

The Bottom Line
Whether Nike or Under Armour choose to increase the competitive pressure on lululemon in the yoga category, they're definitely a strong presence in other markets like cycling and menswear, and it will be interesting to see the extent to which lululemon chooses to compete directly with them or tries to avoid them. While lululemon has a reputation for sexy and attractive designs, Nike and Under Armour have quality and product R&D on their side and will likely prove to be increasingly formidable rivals.

I haven't changed much about my lululemon outlook – I still model a level of revenue growth (16%) and free cash flow (21%) that will have the company at (or near) the top of the athletic apparel market by the end of the decade. Even with that aggressive scenario, fair value comes in around the mid-$60s, meaning that even with this highly negative reaction to earnings (or more likely the CEO resignation) these shares aren't exactly a huge bargain.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Fundamental Analysis

    Inventory Valuation For Investors: FIFO And LIFO

    We go over these methods of calculating this component of the balance sheet, and how the choice affects the bottom line.
  2. Investing Basics

    DCF Valuation: The Stock Market Sanity Check

    Calculate whether the market is paying too much for a particular stock.
  3. Bonds & Fixed Income

    Equity Valuation In Good Times And Bad

    Learn how to filter out the noise of the market place in order to find a solid way of determing a company's value.
  4. Active Trading

    The Fed Model And Stock Valuation: What It Does And Does Not Tell Us

    Learn about this popular stock market valuation model and how accurate it has been over the years.
  5. Markets

    Investment Valuation Ratios

    Learn about per share data, price/book value ratio, price/cash flow ratio, price/earnings ratio, price/sales ratio, dividend yield and the enterprise multiple.
  6. Economics

    What is a Complement?

    A good or service that’s used in conjunction with another good or service is a complement.
  7. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  8. Retirement

    Ipsy Review: Is It Worth It?

    Discover the history of ipsy, how much packages cost, options available for membership, major competition and what the future looks like for the company.
  9. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  10. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  1. How does a cost-of-living adjustment (COLA) affect my salary?

    Some companies build salary adjustments into their compensation structures to offset the effects of inflation on their employees. ... Read Full Answer >>
  2. Where can you buy NetSpend reload packs?

    You can only purchase NetSpend reload packs at Giant Eagle, Albertsons, Roundy's and Pathmark supermarkets. NetSpend cards ... Read Full Answer >>
  3. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  4. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
Trading Center