Morgan Stanley downgraded Lululemon Athletica to “Equal-weight” from “Overweight” on waning confidence in a recovery in the company’s core U.S. market. The lead analyst for the financial services corporation, Alex Straton, also cut her price target from $346 to $280.
The downgrade comes as Lululemon’s shares fell 19.8 percent on Friday, June 6, after the retailer trimmed its earnings guidance for the year due to the impact of tariffs while projecting second-quarter guidance below Wall Street targets. The earnings pressure, to a lesser degree, reflects a more cautious consumer, with Lululemon slightly increasing its expectations for year-end markdowns.
On Monday, June 9, shares slid $6.23, or 2.4 percent, to $259.04.
In a note, Straton said she was less convinced that same-store sales in the Americas, a key performance indicator for Lululemon and driver of the stock, would show a meaningful turnaround this year.
The analyst noted that, before Lululemon’s quarterly report, Morgan Stanley and other investors were hoping for a reacceleration in U.S. growth, given the strengthening of U.S. credit card sales data and the return of new offerings at Lululemon to historical levels.
U.S. comparable sales, however, declined 2 percent in the first quarter, compared with flat in the prior quarter and below Wall Street’s expectations of a 1 percent decline. Straton wrote, “This confirmed our prior concerns that 1) newness alone is unlikely to re-ignite home market growth and 2) there are likely other, potentially more powerful dynamics contributing to LULU’s Americas challenges.”
Straton said newer challenges potentially include increased competition from “new sportswear brands and regular-way fashion players entering the category” and Lululemon giving back some younger consumer mindshare after finding gains tied to the pandemic. Other potential challenges include risks associated with shifting assortments from less performance-based ranges to more everyday wear, potentially long product replacement cycles, slowness in entering relevant categories and silhouettes compared to peers, North American store size and layout constraints, and product organizational employee turnover.
Straton added, “While issues such as store size, layout constraints and product org. turnover are likely fixable, challenges stemming from higher competition are most likely permanent.”
Straton also expressed concern that even if Lululemon beats earnings expectations on profitability in upcoming quarters, investors are unlikely to reward the stock until North American sales show consistent improvement.
Outside North America, the analyst said she has been less optimistic than the market on Lululemon’s growth in China over the medium term. She further stated that Lululemon’s decision to forecast slightly higher markdown rates for the year, combined with rising inventory levels, leads her to believe that Lululemon faces more inventory risk than previously estimated. Straton wrote, “This development has shifted us more negative on the prospect of markdown risk than prior, though we continue to believe LULU will remain less promotional or fashion-risk-susceptible than specialty retail peers.”
The brokerage firm has trimmed its medium-term sales growth outlook for the Americas to low single digits and now views consensus forecasts through 2028 as “fair-to-high,” particularly on profit margins, which may face pressure from ongoing tariffs and increased spending to expand internationally.
While Lululemon’s current valuation, trading at around 18 times forward earnings, still reflects a premium to peers, Morgan Stanley said the stock is likely to de-rate further as growth moderates and becomes more reliant on markets outside North America.
Image courtesy Lululemon
