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Lululemon Supplier Woes Are Transparent As Pants

Lululemon Athletica's (LULU) see-through pants fiasco sent shares falling Tuesday, highlighting the fast-growing yoga apparel chain's recurring supply chain strains.

Late Monday Lululemon said it found certain recent shipments of its Luon pants and crops had an unwanted level of sheerness that fell short of its high standards. It pulled the affected pants from its shelves over the weekend. The problem items represent about 17% of all women's pants in its stores.

The retailer's shares sank nearly 3% to 64.08 in the stock market Tuesday. They hit 62 early, the lowest since late August, after falling 4% on Monday.

The Taiwan supplier — Eclat Textile Co. — reportedly said the pants were not "problematic.

Nevertheless, this isn't the first supply chain issue for Lululemon. In 2010 and 2011 it struggled to keep up with demand. The problem: Lululemon is stretched too thin when it comes to suppliers and quality control.

"Lululemon is a very fast-growing company that probably hasn't invested enough in people to do the quality control it needs," said Sterne, Agee & Leach analyst Sam Poser. "They have a very narrow assortment, and when there's a problem with big selling items, it's very impactful.

Supply Chain Oversight Therein lies its most recent mishap with the Luon pants.

"There does appear to be a major quality control problem in Asia, where the Luon pants are produced," Poser wrote in a note on Tuesday. "While the factories in question have been producing fabrics for Lululemon since 2004, it appears that there is not appropriate oversight in place. It is essential that Lululemon puts in place appropriate oversight at its production facilities to avoid future mishaps.

Lululemon faces a supply chain issue common to many expanding firms, said Brian Sozzi, chief equities analyst at independent researcher NBG Productions. It has a shortage of suppliers.

"When you have a company growing so fast, it needs more suppliers to get the products to the stores that are in strong demand," he said.

And Lululemon doesn't have a broad-enough supplier base to assure it gets the quality products to its locales on a consistent basis, Sozzi added.

In the past, when it's had problems with shortages, it was because it didn't have the base of suppliers to get the products into the stores, Sozzi said.

"And if the products aren't in the stores, you risk disappointing what is a very loyal Lululemon customer," he added.

Big Sales Impact The yoga pants mishap will cost Lululemon on the sales and earnings front. In a press release Monday, it said that up until March 17, it had expected first-quarter same-store sales to rise 11% vs. a year earlier with overall revenue of $350 million and $355 million. In light of the Luon pants shortage, it now sees comps up 5% to 8%. Sales will come in at $333 million to $353 million. At $343 million, that would be a 20% rise, the smallest gain in nearly four years.

Lululemon's latest supply chain snag comes ahead of Thursday morning's Q4 report. Analysts polled by Thomson Reuters forecast a 45% rise in earnings per share to 74 cents. They expect a 30% sales gain to $482.9 million.

Poser, meanwhile, downgraded Lululemon shares to neutral on Tuesday.

"We suggest a wait-and-see mode until the Luon pant problem is resolved," he wrote.

Lululemon "did the right thing" by proactively pulling the Luon pants from the floor, Poser said in his note.

"However, unlike prior events, the pants are a mainstay of Lululemon's assortment, and customers may go elsewhere if the issue is not quickly resolved," he added.

Lululemon's woes didn't seem to help rival apparel makers. Under Armour (UA), which has been making a bigger push into women's clothing, fell more than 3% to 48.48. Nike (NKE), which reports earnings Thursday, sank 32 cents to 53.84.