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Lululemon At A Crossroads

Since March, the yoga-wear company has been hit with a series of setbacks. For the first time ever, it is being forced to confront hard questions about its performance and future.

Posted on July 8, 2013, at 12:20 p.m. ET

Lululemon Athletica is at a crossroads.

Over the years, the high-end yoga-wear maker has built up a cult following among both consumers and investors. But recent issues, among them a falling stock price, shareholder lawsuits, quality control problems, and executive departures, have cast a dark shadow over the brand, forcing it for the first time ever to confront hard questions about its performance and future.

A Lululemon representative did not respond to multiple requests for comment.

Since March, when Lululemon was forced to recall 17% of its iconic, expensive yoga pants for being too sheer, the company has been hit with a series of setbacks.

Two months after the recall, a pension fund filed a lawsuit against Lululemon, accusing it of increasing potential executive bonuses before making news of the sheer-pants problem public.

In June, Lululemon's chief executive, Christine Day, a superstar ex-Starbucks executive who's led the retailer for five years, abruptly said she would resign for "personal reasons" once a successor was found. The announcement spurred an 18% stock price plunge, the most in more than four years. The company is now searching for not only a new CEO, but also other executives to oversee product design and supply chain functions.

In the latest blow to the company, Reuters last week reported that a group of shareholders filed another lawsuit against Lululemon. The complaint alleges that Lululemon artificially inflated its stock price between March 21 and June 10 by concealing it was cutting production costs, which led to the sheer-pants recall, and that it was selling yoga pants at a discount to protect market share. Lululemon is also accused of hiding it was in talks to replace Day, who's led the company for five years. The suit seeks class-action status for stockholders during that time period.

The company's chairman, Dennis "Chip" Wilson, also quietly filed on Friday to sell 3.4 million shares of stock, reducing his control of Lululemon to 25% from 28%, though analysts don't think there is anything nefarious about the sale.

Lululemon's recent problems are diametrically opposed to the Vancouver, Canada-based company's broader performance since going public in July 2007. Thanks to its high-quality, fashionable products and grassroots community-based marketing efforts, Lululemon has been able to command $98 for yoga pants and $64 for tank tops. Annual sales have surged by almost 10 times since the year ended Jan. 31, 2007, to $1.4 billion. Since its IPO, its share price and store locations have more than quadrupled, and profits have also soared.

Lululemon has been able to both weather the U.S. recession and protect its niche from growing rivals such as VF Corp.'s Lucy, Gap Inc.'s Athleta, and even Nike Inc. because of its unique and strong culture.

Sam Poser, an analyst at Sterne Agee & Leach, says it all comes down to finding a replacement for Day who fits with the company's culture, which he describes as a "needle in a haystack" task.

"The product's great, but what's making them successful is significantly more than that — if it's going to get moved in on, it's going to happen only if the culture changes," said Poser, who has a neutral rating on the shares.

"The overall experience between service and relationship and product and community, nobody else can hold a candle to that, and nobody will invest in those kinds of people and pay the wages Lulu pays," he said, citing the fact that the company didn't cut staffing hours during the sheer-pant fiasco even though it knew sales and profitability would fall.

Analysts have grown less bullish on the brand's growth trajectory in North America and its ability to break into men's activewear. More worrisome is that its loyal fan base has showed signs of cracking. YouGov BrandIndex, a daily measure of brand perception among the public, shows Lululemon's so-called "buzz score," flipped to negative on July 2 from positive at the start of the year and blogs devoted to all things Lululemon have also expressed dismay. The author of the Lululemon Addict blog — with multiple posts a day about the brand's products — has complained about the quality and fit of the clothes and is building a section on the site to review other yoga-wear products.

Still, Camilo Lyon, an analyst at Canaccord Genuity, says that fundamentally, demand for the brand hasn't yet ebbed.

"Almost everything that can go wrong this year so far has," Lyon, who recommends buying the shares, wrote in a note today. "However, the most important factor, consumer appetite for the brand, does not appear to have been permanently damaged as a result of the product recall issues that are now fully behind it. As such, we believe the negative sentiment should begin to turn as positive data points emerge."