New Lululemon CEO faces compounding pressures as she takes over top job

Long-time Nike Inc. NKE-N veteran Heidi O’Neill is set to take the helm as CEO of Lululemon Athletica Inc. LULU-Q on Tuesday but faces an embattled activewear retailer that is in worse shape than when she agreed to take the job last spring.

Investors in Lululemon sent the stock to an eight-year low on Friday, after worse-than-expected second-quarter earnings and another cut to its financial forecasts added to fears about the company’s turnaround prospects – and compounded the pressures on its incoming chief executive officer.

On Thursday, after markets closed, the Vancouver-based apparel maker lowered its forecasts for the second time in just three months, and reported that its second-quarter revenue fell by 5 per cent on a constant currency basis, to US$2.4-billion.

The company signalled that things will only get worse in the third quarter, with North American sales expected to fall by a percentage around the mid-teens, while international markets should grow by 3 to 5 per cent.

“The business is still searching for a bottom,” Stifel analyst Peter McGoldrick wrote in a research note on Thursday evening, adding that the company’s turnaround trajectory had become more clouded. “Using revenue as a proxy for brand health, the trough is not yet set.”

Lululemon’s stock has lost more than 50 per cent of its value over the past year. On Friday, the company’s share price fell by nearly 17 per cent to just over US$101.

The performance of Lululemon’s stock “reflects uncertainty that management has a handle on stabilizing let along fixing the business,” William Blair analyst Sharon Zackfia wrote in a report on Friday.

She added that the brand’s recovery is now looking harder to achieve, and will require structural changes, including further improvements in the time it takes to bring new products to market, and better development of fresh styles to offset declining sales in leggings – previously a core area of strength for Lululemon.

The Canadian retailer was a pioneer in offering activewear that was fashionable enough to wear outside of gyms and yoga studios, now a multibillion-dollar sector of the retail market. Its growth has attracted much more competition in recent years, while Lululemon has been losing traction with shoppers looking for fresher styles.

The company’s performance has dragged particularly in North America, as rivals such as Alo, Vuori, Gymshark have won customers by staying on top of trends, and as e-commerce brands have raced to market with cheaper “dupes” of the most popular styles.

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North America, Lululemon’s biggest and most important market, has seen comparable sales slip in recent years. That is an important metric, which compares sales at stores open more than a year, removing the impact of new store openings or closings on results. While demand has slowed among North American customers, Lululemon continued to see growth in international markets.

But Thursday’s report showed a surprising decline in mainland China, where Lululemon’s comparable sales fell by 8 per cent in the second quarter on a constant currency basis – a major negative swing from 13-per-cent growth in the previous quarter.

Lululemon was hit hard by a public-relations gaffe in China this spring. After using a Japanese taiko drum during a marketing event on the Great Wall of China on May 30 – a large-scale yoga festival at the landmark, billed as a celebration of Chinese culture – the retailer was the subject of severe criticism on social media and several negative news reports.

The results in China were a surprise, Stifel’s Mr. McGoldrick wrote, but in addition to the controversy, there are also structural factors that “raise questions on China growth, previously the most important growth driver” for Lululemon.

Among those were China’s annual “618” e-commerce shopping festival in June, which delivered weaker results for the brand than last year, reflecting a larger slowdown in consumer spending in that market. Lululemon executives said on Thursday that they are planning more marketing and events in large Chinese cities, in an effort to restore “brand heat.”

Lululemon’s struggles in China and North America “push the recovery timeline further out,” Bank of America analyst Lorraine Hutchinson wrote in a note on Friday, adding that even though executives on a Thursday conference call “laid out a detailed product and marketing plan to try to stabilize the business,” the forecasts they provided did not indicate any expected improvement as a result.

“With a new CEO starting next week, it’s difficult to have visibility on strategy but we were surprised to hear that store openings and marketing will continue as planned,” Ms. Hutchinson wrote.

Lululemon executives have emphasized that the company is hard at work on its “action plan” to address its struggles, including spending more on advertising and community events, speeding up development times for new styles, and cutting costs.

“We anticipated our plan would take some time to gain traction as we bring in new innovations, elevate our store and digital experience, and increase and redirect our marketing spend. But we expected a better response than we are seeing as we enter the second half of the year,” chief financial officer and interim co-CEO Meghan Frank said during the call with analysts on Thursday.

Ms. O’Neill’s arrival as CEO could introduce some further uncertainty, “as some speculate she could also set initial expectations even lower,” wrote Ms. Zackfia of William Blair.