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See-Through Yoga Pants or Not, LULU Still a 'Buy': Pros

Tuesday, 19 Mar 2013 | 12:50 PM ET
See-Through Pants a LULU of a Problem
Roxanne Meyer, UBS analyst, explains how a recall at Lululemon has lowered the company's first quarter revenue forecast.

In the world of yoga pants, tightness be an asset, but sheerness often isn't—an apparel maxim that Lululemon Athletica shares illustrated on Tuesday.

Following Lululemon's announcement that it expects a yoga pants shortage and a "significant impact" on its financial results due to a see-through pant recall, the stock posted its worst three-day loss since August intraday on Tuesday. After the warning, several analysts cut their price targets, but many still maintained "buy" ratings on the stock, citing Lululemon's continued potential for high growth.

"We certainly are calling into question the growing pains that the company is certainly undergoing," said Roxanne Meyer, an analyst at UBS. "What's really clear though is that the demand is out there. And in some cases, they're just not keeping pace with that demand."

Sarah L. Voisin | Washington Post | Getty Images

On Monday, Lululemon said about 17 percent of all in-store women's bottoms were affected by the unacceptable "level of sheerness."

Following the company's announcement, UBS analysts cut Lululemon's price target to $77 from $82, but reiterated a "buy" rating.

The company, which reports fourth-quarter earnings on Thursday, forecast fiscal first-quarter sales of $333 million to $343 million, down from the $350 million to $355 million it had previously guided before the sheer pants announcement.

Lululemon also changed its same-store sales growth estimates from the 11 percent it had expected to 5 percent to 8 percent. Meyer highlighted this previous 11 percent number on CNBC's "Squawk on the Street."

"That bucks the trends of the entire retail industry when you think about the macro issues going on in February—the adverse weather that was there," she added. "So the underlying business is healthy—there's a ton of consumer demand. They continue to be the leader in what is the single best growth category in apparel retail."

ISI Group remained even more bullish on Lululemon's growth story with a $100 price target and a "strong buy" rating on the stock. Analysts said the quality issue should be temporary in nature, adding that "it is still one of the best long-term growth stories in all of consumer discretionary, and we would be buying on the pullback."

ISI suggested that the company's relatively small supply chain has been overworked to build inventory and boost comparable sales growth. It added that the company needs to take a more direct interest in its supply chain, an opinion that other analysts echoed.

Since Lululemon's high multiple highlights its status as "one of the premier growth stories out there," Sterne Agee analysts said it is important that these operations aren't overlooked. On Tuesday, analysts downgraded the stock to "neutral."

"We are concerned that Lululemon does not have the appropriate presence in and around its factories," the report said. "While the factories in question have been producing fabrics for Lululemon since 2004, it appears that there is not appropriate oversight in place. We believe it is essential that Lululemon puts in place appropriate oversight at its production facilities to avoid future mishaps."

Unlike the items involved in previous production mishaps (such as last year's neon color bleeding problems), the pants are a mainstay of the company's product line, and consumers may go elsewhere if the issue isn't resolved quickly, Sterne Agee argued.

In a Key Banc Capital Markets report, analysts noted that this supply chain issue is the most significant misstep of its supply chain issues to date. In recent quarters, the company has also frequently had to expedite goods via airfreight, analysts added.

"All of this points to a strained supply chain," they said. "We expect this most recent issue to further heighten the scrutiny on the supply chain, which could distract from the near-term seeding of international markets."

Analysts will be paying close attention to Lululemon's upcoming earnings report for further light on the sheer pants problem, an issue that Canaccord Genuity said would cause shortages that persist into the second quarter before comps rebound in the second half of the year.

—By CNBC.com's Katie Little; Follow on Twitter @Katie_Little_

Additional News: Lululemon Withdraws Sheer Yoga Pants; Stock Drops

Additional Views: Window Shopping for Profits

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Disclosures:

Roxanne Meyer does not own Lululemon stock. KeyBanc Capital Markets expects to receive or intends to seek compensation for investment banking services from Lululemon within the next three months. Sterne Agee expects to receive or intends to seek compensation for investment banking services from the subject company and/or companies in the next three months. ISI does and seeks to do business with companies covered in this research Report and has received non-investment banking compensation in the past 12 months.

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