Lululemon is 'the better house on a bad block' and that has investors overlooking its problems

On the surface, Lululemon had a great week.

It reported a 17% jump in sales for the first quarter on Wednesday, thanks in part to surging sales in its men’s sector. Men apparently love those ABC (“anti ball crushing”) pants.

The shares rose, touching a new high for the past year on Thursday.

But Lululemon’s results included some worrying signs, namely that its inventory continues to climb — fast. In the quarter, inventory rose 21%.

In other words, as my colleague Linette Lopez has noted, it can’t sell those stretchy pants as fast as it is making them. Also, Lululemon’s profits fell and same-store sales, which is growth at stores opened more than a year, rose just 3%.

So why such a great reception? The context here matters: The report came on the heels of a dismal results from everyone from Nordstrom to J. Crew, all of which have been losing their reputations as premiere retailers.

“Lululemon was not stellar by any means,” Betty Chen, Managing Director at Mizuho Securities, said to Business Insider. “It was still sort of the better house on a bad block or in a bad neighbourhood,” so, it’s a “relatively better company or stock for investors to look at.”

Lululemon doesn’t see it this way. CEO Laurent Potdevin said in press release that, “we are pleased with our first quarter performance, delivering strong sales results and gross margin that exceeded expectations. We finished the quarter with our inventory levels rebalanced and on track to achieve our goals for the year.”

No discounting

One reason that Lululemon is still wrestling with inventory is that it famously does not yield to the industry’s most dangerous trend: that of incessant discounting. It’s a decision that helps maintain a premiere image and keeps stores looking tidy.

The company doesn’t have a massive eyesore of a clearance section. Rather, you have to dig through to find a sale item, Chen explains, making it more of a pleasant surprise rather than the expectation. 

“There’s this perception that they’re rarely on sale,” she said, so a discount will get snapped up quickly. 

But Lululemon has taken another route that’s gotten some retailers in trouble in the past: using outlet stores to move excess merchandise. Michael Kors or Coach both overbuilt their outlets, tarnishing their premium reputations in the process. And both have sought to undo some of that discounting to regain their status.

Lululemon has opened up seven outlet stores since the first quarter of fiscal 2015, ” in order to ensure appropriate liquidation capacity for our growing full price business,” as CFO Stuart Halseden put it on an earnings call.

Right now, that’s too few to hurt the main business, because most customers aren’t near outlets — so the discounted apparel isn’t even something they can consider. In total, Lululemon has 373 stores.

Lululemon says it’s working to smooth things out.

“We delivered an accelerated progress in recovering our gross margins, and completed our work to rebalance our inventory levels in an orderly and disciplined manner,” Halseden said.

Additionally, “we are not dealing with the prior inventory overhang, and it should translate into a better experience for our guests as well,” Halseden said.

But perhaps more importantly, comparable sales are up and its men’s business is thriving, which is far more than most other apparel retailers can say these days.

NOW WATCH: We tried Lululemon’s ‘anti-ball-crushing pants’ to see if they lived up to their name

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