Lululemon Athletica Inc Accounting Theory

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LULULEMON ATHLETICA INC.

Application of Accounting Theory

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Company background^[1]

Lululemon Athletica Inc., is a yoga inspired athletic apparel company and was founded in 1998 by Chip Wilson: styled as Lululemon ahletica. This company produces a clothing line and runs international clothing stores from its headquarters in Vancouver, British Columbia, Canada. Lululemon is recognized as one of Canada’s fastest growing brands. As of February 2015, the company operated 280 store locations worldwide in addition to its online store.

They promote a set of core values which include, developing the highest quality products, operating with integrity, leading a balanced and fun life, and nurturing entrepreneurial spirit. Their primary target is “a sophisticated and educated woman who understands the importance of an active, healthy lifestyle.” Also, they primarily conduct their business through two channels: corporate-owned stores, and direct to consumer.

Review of financial performance

Lululemon’s quarterly report, dated September 10, 2015^[2], shows some of the accounting policies and standards they use or have currently changed to.  One of which deals with inventory measurement, and the fact that they must measure inventory at lower of cost or NRV, instead of lower of cost and market value which this will be mandatory for all public companies after December 15, 2016 (this could have some implications of earnings management, by being able to value inventory differently).  By doing this, this shows more of a current cost, as well as is slightly more on the conservative side which is considered signalling for a high type firm.  Another change is that they are updating the way that revenue from contracts with customers will be recognized.  They are going to recognize revenue to show that a transfer of goods or services happened and shows the consideration of which the customer estimates it will cost them, this makes more of this information decision useful.

By doing these things, Lululemon is making their financials more reliable to investors by showing inventory as current costs, as well as recognizing revenue as early as possible through the transactions with customers. This will better help investors with making these tough investment decisions by giving as little insight to what is going on inside the company, and maybe even signalling they are a high type firm.  

Inventory is a huge part of a retail company, and sometimes too much inventory can cause more issues than expected.  While they saw an increase of 55% of inventory this year, their inventory turnover ratio fell by 0.5%^[3].  This ratio could be used by creditors or investors in determining how management is doing with inventory levels (the evaluation of management).  The reason for this spike was the result of a few factors:

• Lululemon opened up 66 new stores over the year, so there needed to be inventory (persistence of earnings, permanent)
• They experienced a 29.5% growth in their direct customer channels
• Shipments coming from the West Coast were backed up

These items all together made it hard to move inventory quickly, but this was just a one-time event, that would only affect the current year (persistence of earnings, transitory).  

Share and market performance

On September 15, 2010^[4], Lululemon’s share price dropped 11% despite their over expectation performance where they exceeded almost all market expectations, including Wall Street. Despite the good news of the company, the share price still dropped dramatically the day the earnings announcements were released. Reasons for this negative market reaction despite the positive earnings announcement is largely due to the decrease in the company’s profit margins, which was around 5% less than the previous years. This proves that the information provided within the financial statements is useful to investors when they are making a decision. Investors look at all areas of the financial statements and do not limit their attention to one item, they instead look at the bigger picture because investors are rational and would charge a premium for a riskier stock, making them risk averse. They want to generate the best return for their dollar. As you can see from the charts below that after the news was released the share price rapidly dropped which shows that the market is running efficiently because the share price fully reflects all available information about the company. This goes beyond financial information, in Lululemon’s case it was due to the quality control controversies in recent years, and combination of the brand damage done by previous ownership which made investors reluctant to invest. This is evident in the post announcement drift because after September 10, the share price continued to fall until into November because investors’ confidence in the company was low, most likely due to the profit margin and ownership issues with Chip.

[pic 3]                                      [pic 4] (Lululemon, Nasdaq, 2015) ^[5]                                                               (Nike, Nasdaq, 2015)^[6]

We looked at Nike and Lululemon’s stock price during this period to compare their performance as top competitors in the athletic wear industry. As you can see Lululemon’s stock price is approximately half of that of Nike’s  and this is because of the negative publicity that Lululemon had been facing leading up to this point with their “see through pants” scandal and their corporate control issues. Nike is however a leader in the athletic wear industry, so this does not necessarily mean Lululemon is a low performing firm simply that they are not performing as well as the industry leader.  In terms of their systematic risk, exchange rates and interest rates will play a large role as Lululemon is based in Canada, and their biggest markets are beyond their borders.  In regards to competition, Lululemon and Nike hold a beta of 0.80 and 0.54 respectively, which indicates that Lululemon is less volatile than the market, but more volatile to market factors and risk than Nike. For example if the market was to fluctuate up or down 10%, Lululemon would fluctuate around 8%, whereas Nike would only be 5%. This means that Lululemon’s stock has a higher risk associated with it when compared to Nike.