Lululemon 'can't keep outgrowing market' when it's the leader

Athletic apparel brands Nike (NKE) and Lululemon (LULU) are falling Friday morning as the two stocks take a hit despite both companies topping their latest earnings expectations. Bernstein Senior Analyst Aneesha Sherman shares her insights on the athletic wear stocks, particularly Lululemon as it continues to capture more market share from luxury retail consumers.

"Year-to-date, in January [and] continuing into February and early March, the trends have been very weak in the US market, in particular. Management talked about this on the call yesterday, they said there was some challenging US consumer dynamics — traffic is flowing, conversion is flowing," Sherman says. "I think it's a combination of macro, the middle-income consumer is getting squeezed right now and that is the Lulu consumer..."

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Editor's note: This article was written by Luke Carberry Mogan.

Video Transcript

JARED BLIKRE: I want to shift gears to Lululemon, got to talk about that as well, strong results. I mean, strong reaction at least in the stock market to about this. But I guess some of the other analysts were worrying about the current environments. Fourth quarter is strong. But there are some trends month to date that seem to be troubling some analysts. I'm wondering if you can comment on that?

ANEESHA SHERMAN: Yeah. The trends recently, so holiday was very strong in December and that's what drove the strong Q4 performance. But year to date in January and continuing into February and early March, the trends have been very weak in the US market in particular. And management talked about this on the call yesterday, they said there's some challenging US consumer dynamics. Traffic is slowing. Conversion is slowing.

I think it's a combination of macro. I mean, the middle income consumers getting squeezed right now and that is the consumer. But it's also Lulus getting really big in the US. It is the number one market share holder in women's apparel. And you can't keep outgrowing the market once you're the market leader. And so a little bit of that slowdown that was overdue is finally caught up to the stock.

SEANA SMITH: Aneesha, some of that slowdown a bit surprising to you, given the fact that high end consumer has held up so strong up until this point in Lulu hasn't really seen much of that pressure before?

ANEESHA SHERMAN: But I think the key in what you're saying is up until this point. We are seeing weakness in the high end consumer. Now where other premium brands. If you talk about Nordstrom, we talk about Coach, you talk about caring. They are seeing weakness in that consumer, which is the Lulu consumer. So it is not just low income pressure anymore. It is really creeping up the income spectrum and is hurting that Lulu consumer in a way that it wasn't a year ago.

JARED BLIKRE: Aneesha, since we're in between earnings periods right now, any trends or any thoughts on trends that you've seen develop over the last quarter, heading into the next one, what are the things that are on your radar right now?

ANEESHA SHERMAN: We're seeing continued softness in the US market and consumer. Once we get to the summer, I think we will start to anniversary. Some of last year's softness so we should see some incremental growth. And particularly, for the sportswear brands who are seeing some big sporting events coming up the Paris Olympics. The euro cup and soccer that should drive some traction as well.

So H2 is looking more optimistic than H1. H2 order books are stronger than H1. And H2 inventory levels will be cleaner than H1. So it does feel like it's a bit of a year of two halves where we're still in the thick of the H1 weakness. But things will start looking better as we get into mid-year.

SEANA SMITH: Aneesha, what do we need to see from Lululemon to spark some of that re acceleration of growth?

ANEESHA SHERMAN: I think we need to see some growth in the men's business. So this has been a big growth area for them, which was meant to be helping to offset some of the slowdown in the core women's business. But men's has actually underperformed women's this year. And Lulu CEO on the call yesterday talked about how men are a little bit more conservative with buying as well.

But he also talked about new innovation that they have out. They have new men's pants, new men's shoes. So if we see that starting to work in the men's business starts picking up, that may offset some of the weakness in the women's business as it starts to mature and slow which will be a positive catalyst for this.

SEANA SMITH: Now our colleague Brad Smith very excited about the new lineup of men's shoes over at Lululemon. All right. Aneesha Sherman, always great to talk to you. Thanks so much for joining us here Bernstein senior analyst. Thanks Aneesha.