Capacity Restrictions Will Limit Lululemon’s Growth in Q4

The growth rebound is gaining steam at lululemon athletica (NASDAQ: LULU). The athleisure and sportswear specialist announced sharply higher sales on Dec. 10 thanks to its booming online selling channel. Gains in that segment more than offset customer traffic declines while COVID-19 pressured in-store shopping volumes.

The results paint a bright picture for the holiday shopping season that recently started, although CEO Calvin McDonald and his team are staying cautious about the short-term growth outlook as the pandemic keeps capacity restrictions on its stores.

A woman holds a yoga pose.

Image source: Getty Images.

Sales bounce

Sales growth shot past Wall Street’s expectations to land at a 22% increase for the quarter ended Nov. 1. Lululemon posted $1.1 billion in revenue as shoppers directed more spending toward its athleisure, running, and yoga products. While growth was strong in most geographies and across many of its merchandise categories, customers showed a clear preference for the online sales channel.

Digital revenue jumped 93% and completely offset the chain’s weak performance at stores. Its physical locations are operating about 18% below year-ago levels.

That in-store decline sat at just over 50% in the previous quarter, so there was a solid rebound over the last few months. “Our third quarter results demonstrate the strength of lululemon across channels and markets,” McDonald said in a press release.

Inventory and margins

The chain is holding more inventory than usual with levels jumping 23% year over year. Management has said that it can work through that increase, which came from the temporary store closures in the spring, without slashing prices or booking writedown charges.

That bullish prediction makes sense considering that gross profit margin rose in the fiscal third quarter, improving to 56% of sales from 55% a year ago.

The profitability increase didn’t make its way to the bottom line, though. Instead, lululemon’s adjusted operating margin dropped slightly. Executives said in a conference call that the decline came from temporary costs associated with its latest acquisition, which ensured net income grew at a slower rate than sales this quarter.

Looking ahead to the holidays

Management didn’t issue an official outlook for the holiday quarter, but executives said in the call that a few factors will pressure results over the next few weeks.

Growing COVID-19 outbreaks have sparked a return to tight capacity restrictions in several markets. Its stores, often packed during the holiday season, will likely be operating at significantly reduced traffic levels this year. Overall, shops should be running at about 70% of normal volumes, while the digital segment continues growing, though not as quickly as this latest quarter’s 93% jump.

Factor in these challenges, and the outlook implies a modest fourth-quarter slowdown compared to the 22% top line growth the company just achieved. The chain expects cost pressures to stay elevated in the current quarter too.

The trends imply slowing growth, high inventories, and weak earnings to close out lululemon’s fiscal year. The good news is that these issues appear temporary and are driven by the pandemic rather than any encroaching competitive challenge.

Still, investors should brace for volatility ahead. Lululemon’s long-term growth outlook is as strong as ever, but the next few quarters might bring rocky results.

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Demitri Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Lululemon Athletica. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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