Narrow-Moat Lululemon’s Solid Holiday Sales Tempered by Soft Gross Margin; Shares Overvalued

With the holiday season wrapping up, Lululemon preannounced fourth-quarter revenue in the range of $2.66 billion-$2.7 billion, slightly above our estimate of $2.65 billion and its prior range of $2.605 billion-$2.655 billion. While this sales report implies solid growth of 25%-27%, it was overshadowed by a soft gross margin outlook, apparently due to discounting to clear excess inventory. Specifically, Lululemon now projects a gross margin decline of 90-110 basis points as opposed to the prior view of an increase of 10-20 basis points. The new range implies a gross margin of 57%-57.2%, which would be its first fourth-quarter gross margin below 58% since 2018. As discussed in our Dec. 9 note, Lululemon’s third-quarter ending inventories were up 85% from the previous year. At the time, management brushed off concerns that markdowns would be required, but slowing consumer spending appears to have taken a toll. However, Lululemon was able to mitigate the impact of the gross margin through operating cost leverage. The firm now expects a 100-120-basis-point improvement in its selling, general, and administrative expenses, outperforming our 80-basis-point estimate and its prior range of 30-50 basis points.