Lululemon Guided Soft in March and Softer in June. I'm Buying the Second Punch

Six weeks ago I wrote that a premium apparel brand earning enormous returns on capital had been marked down like it owed the crowd money. The stock was $143. I said buy a starter, keep your powder dry, and add if it fell another fifteen percent.

It fell another twenty two. The after-hours quote is about $111. The crowd did exactly what I told you it might.

So here is the only honest thing to do. I wrote down, in advance, the four things that would prove me wrong. The company just reported. Let me check my own scoreboard in front of you instead of quietly moving the goalposts the way most people do when the price goes against them.

The Scoreboard I Wrote Before the Quarter, Marked Against the Quarter

I gave you four conditions. Any one of them and the thesis is broken. None of them and you sit on your hands. Here they are, graded.

Condition one. Gross margin breaks fifty three percent on a trailing basis. That would tell you the markdown habit has gone structural. Q1 gross margin came in at 54.2%, down four hundred and ten basis points. That is ugly. It is also a single quarter, and the trailing number still sits around 55.7%, above the line I drew. Not tripped. On the watch list, with a red light blinking.

Condition two. Americas same store comps decline more than five percent for two quarters in a row. That would tell you the brand problem is no longer a product cycle problem. Americas comps fell five percent as reported and six percent in constant currency in Q1. That is one quarter at the line and, in constant currency, through it. The clock is now running on the second. This is the condition I am watching above all others, because it is the one that decides whether this is a headache or a tumor.

Condition three. Net debt appears on the balance sheet to defend the buyback. That would tell you management confused returning capital with destroying it. It did not happen. The company still sits on roughly $1.5 billion of cash and no funded debt. The fortress is intact.

Condition four. The new chief executive leaves inside eighteen months. She has not started. Heidi O'Neill, who came up running product and consumer at Nike, takes the chair on September 8. You cannot quit a job you have not begun.

So the count is one condition half tripped, one condition flashing amber, two conditions clean. The thesis is not broken. It is being tested in the exact place I said it would be tested. That is not a reason to flinch. It is a reason to pay attention to the right number, which is the Americas comp, and to stop staring at the ones that do not matter.

What Actually Happened, in Plain Numbers

The headline that knocked the stock down roughly eleven percent after hours was the June guide-down on top of a soft March guide. Read that slowly. In March management said things would be soft. In June it said softer. That is the kind of thing that makes algorithms sell first and think never.

Underneath the headline:

Revenue grew four percent to $2.47 billion. Two percent in constant currency. Not a collapse. A stall.

The split inside that number is the whole story, and the crowd refuses to label the columns. Americas comps fell five percent, six percent in constant currency. China revenue grew thirty percent, twenty three percent in constant currency. Rest of World revenue grew thirteen percent, nine percent in constant currency. If you insist on comps, China was up twenty and Rest of World was up five. The part of the business that compounds is still compounding. The part that is sick is the home market.

Operating margin fell to 11.2% from 18.5%. Earnings per share came in at $1.69 against $2.60 a year ago. Management now expects full-year operating margin to fall roughly three hundred and eighty basis points year over year; tariffs are a major part of the hit, not the whole hit, and the guide assumes no IEEPA tariff refunds. Free cash flow last year was about $920 million, down forty two percent, on a free cash flow margin of around eight percent.

This is a business running at a fraction of its own potential while still throwing off nearly a billion dollars in cash and earning around thirty cents of operating profit on every dollar of invested capital. Read that sentence again. Thirty percent returns on capital is not the signature of a broken franchise. It is the signature of a very good one having a very bad year.

The One Line on Management That the Buyback Earned

I have to give them a demerit, and I will not pretend otherwise.

The company bought back 2.2 million of its own shares in the quarter at roughly $165. The after-hours quote is $111. They are underwater on capital they deployed weeks ago. There is still about a billion dollars of buyback authorization left.

Show me the incentive and I will show you the outcome. The lesson here is not that buybacks are bad. The lesson is that buying your own stock because it is "down" is not the same as buying it because it is cheap, and the people running the buyback did not wait to find out which one this was. I would rather they sat on that billion and used it lower. The good news, and it is real news, is that they had the cash to make the mistake without borrowing to do it. A company that funds its errors out of petty cash lives in a different universe from one that funds them with debt.

The Circus Left Town. That Changes the Math

When I wrote in April, the proxy fight was live and the board was getting squeezed from two directions. That is settled now. The founder's group reached an agreement on May 27. Laura Gentile and Marc Maurer join the board after the annual meeting, one more product-and-brand director comes by October 1, Wilson accepts an eighteen month standstill, and his stake is capped below 9.9%. Elliott still has more than a billion dollars riding on this.

The reflexive read is that the drama is over and therefore the excitement is gone. The correct read is the opposite. A large founder-owner just locked himself into the boardroom's orbit for the duration of the turnaround, and another billion-dollar activist is still staring at the same outcome. They are not here to write thank you notes. They are here because they want the stock higher, and the founder now has enough boardroom proximity to make the conversation harder to ignore. That is worth more than another consultant's slide deck.

The Lollapalooza Has Not Lifted. The Price Came to Meet It

Six weeks ago I told you most market disasters are several bad things compounding at once, and that Lululemon had all of them running in parallel. They are still running. A deteriorating home market. A leadership chair that stays empty until September. Tariffs. Markdowns. Momentum sellers who do not distinguish a stall from a death.

What changed is the price. In spring the stock was $143 and I argued the bear case was no longer far below the quote. Today the after-hours quote is $111, and the gap between the quote and the pessimistic case has nearly closed.

Run the cash flows again. A haircut base case, with low single digit revenue growth, partial margin recovery, a nine percent discount rate and a modest terminal, lands around $150 a share. Let the franchise heal toward its old normal and you are closer to $245. Push every input to gloom, model the Americas erosion as permanent the way it played out at Under Armour, and you land near $85. The after-hours quote is $111.

Here is the part worth sitting with. Work backwards from today's price and ask what the market is actually assuming. At $111, my reverse DCF says the quote is treating roughly $670 million of normalized free cash flow as the destination. Do not mistake that for a fact from Mount Sinai. It is the arithmetic under my discount-rate and terminal assumptions. That is still a permanent twenty seven percent decline from last year's free cash flow, with no recovery, ever, for a franchise still earning thirty percent on capital. The market is not pricing a rough year. It is pricing a slow funeral.

That might be right. The Americas comp will tell us. But you are not paying for optimism here. You are being paid to wait, and the downside is doing the unusual thing of getting smaller as the price falls, because the net cash and the lower multiple put a floor under the arithmetic that a story stock never has.

What I'd Do, in Plain Language, Again

I said buy a starter in spring and add fifteen percent lower. It is more than fifteen percent lower. So I am adding. Not backing up the truck. Adding the second rung, on schedule, the way you are supposed to when the thing you wanted to own gets cheaper for reasons you already underwrote.

I am keeping capital in reserve for a deeper cut, because a disciplined buyer assumes the bottom is lower than he thinks. If you want a number, the franchise gets genuinely hard to ignore in the low hundreds and below, and a full position belongs on a deeper washout rather than here.

And I am keeping the same four tripwires, because changing your sell rules the moment the price moves against you is how amateurs turn a thesis into a hostage situation. The Americas comp is the one that matters. One more quarter worse than five percent down and I will be back here telling you I was wrong, in writing, without flinching. Until then China revenue keeps compounding while the crowd watches Cleveland.

A Closing Thought, Still With No Question Mark

The hardest thing in this business is doing the same right thing twice when it looked dumb the first time and the price has since told you, loudly, that you were dumb to do it.

I wrote down what would prove me wrong before the quarter so I could not lie to myself after it. The quarter came. One light is amber, one is blinking, two are green. The price is the price. The numbers are the numbers. I am adding the second rung and I am watching one line on one income statement.

The crowd is welcome to its funeral. I have seen this body get up before.