lululemon Investors Cheer Credit Suisse Upgrade To Outperform

• Lululemon Athletica inc. LULU shares are down 17 percent since July 16, having plunged from above $65 to below $55 in September.
• Credit Suisse’s Christian Buss upgraded the rating on the company from Neutral to Outperform, while raising the price target from $57 to $64.
• Expansion in product margins could result in the company beating the EPS estimates, Buss said.

Analyst Christian Buss said that demand is back on track and the company may achieve product margin expansion. He mentioned that a detailed analysis of lululemon's initiatives to improve product margin has revealed that even modest expansion could result in “meaningful upside to street estimates” over the next 18 months.

Buss mentioned that it may be possible for the company to reduce air freight to 25 percent, from the current 45 percent, and lower FOB costs by 4 percent. This appears achievable in view of the following:

1. Even 25 percent air freight is high for the industry, but represents a huge improvement from the current levels
2. A 4 percent reduction in FOB costs aligns with the average devaluation of the Yuan and the Taiwan Dollar.

The analyst elaborated that lululemon's management team has identified 4 main areas that would contribute to product margin expansion:

• Improving the Go-To-Market calendar process
• Lowering air freight reliance
• Improving raw material management
• Re-negotiating cost structure with factories

“Ultimately, we believe lowering air freight reliance and improving raw material management are a byproduct of improving the Go-To-Market calendar, which has been hindered by late approvals in the design phase,” the Credit Suisse report stated.

Lululemon may be able to achieve product margin expansion of 65bp from 2014 and 250bp from 2015. This would take the company’s 2016 EPS to $2.48, which is 8.5 percent higher than the consensus estimate of $2.29.

“This would increase earnings power by 30% from our 2015 estimates and support 22% upside from the current share price,” Buss wrote. The EPS estimates for FY15 and FY16 have been raised from $1.90 to $1.92 and from $2.24 to $2.48, respectively.