Lululemon predicted its own financial ‘downward dog’

Lululemon’s butt-sculpting yoga pants, with their premium price tags, helped the retailer become one of Canada’s hottest stocks in recent years. But the company has stumbled badly. On Jan. 13 Lululemon warned it has seen its store traffic and sales “decelerate meaningfully.” With that announcement, so too did the stock price. Since last June the chain has shed more than 40 per cent of its market value, giving new meaning to the phrase “downward dog.”

Now here’s the thing. All the troubles that have beset the company were flagged seven years ago. Not by an analyst, mind you, but by Lululemon itself, in documents it filed with regulators when it went public in 2007.

The “risk factors” section in a company’s prospectus (and updated in subsequent annual reports) can be one of the most valuable and overlooked sources of information about a company for investors. While these lists can be dry in tone, they’re a snapshot of everything a company’s executives, lawyers and bankers can conceive of going wrong. It’s the ultimate in corporate self-doubt—“How might we fail”—and it’s about the only time most companies will ever highlight their shortcomings. Looking back, Lululemon was incredibly prescient. Consider a few of the red flags Lululemon waved back then:

Risk: We rely on third-party suppliers to provide fabrics for and to produce our products, and we have limited control over them and may not be able to obtain quality products on a timely basis or in sufficient quantity.

Result: See-through yoga pants. Last year’s so-called sheergate scandal saw Lululemon recall many of its popular black Luon pants because they were see-through when stretched. It was a $70-million public relations nightmare Lululemon blamed on a Taiwanese fabric supplier (which denied the charge).

Risk: If we fail to?.?.?.?innovate and provide consumers with design features that meet their expectations, we may not be able to generate sufficient consumer interest in our technical athletic apparel to remain competitive.

Result: Dubious health claims about seaweed-infused fabric. Several years ago the company marketed a Vitasea line of products made from seaweed, which it claimed released “marine amino acids, minerals and vitamins into the skin.” Yet critics said tests found no seaweed in the material at all. The company insists the seaweed is there, but it agreed to ditch all claims of therapeutic benefits.

Risk: Our future success is substantially dependent on the continued service of our senior management.

Result: Upheaval at the top. In 2008, Christine Day took over as CEO, and while there were reports of simmering tensions with founder Chip Wilson, they came to a head after the pants recall. Last summer Day announced she would resign once a new CEO was found. In December the company picked retail veteran Laurent Potdevin as her successor—but not before Wilson trashed the company’s reputation even further when he blamed “some women’s bodies” for causing pants to pill. Wilson has since resigned as chairman, but as Lululemon made clear seven years ago in its prospectus, the company’s business “depends on a strong brand [which may be] tarnished by negative publicity.” That wasn’t an empty warning.

There are two more important risks the company highlighted that explain the precarious situation Lululemon is in today.

Risk: We operate in a highly competitive market and the size and resources of some of our competitors may allow them to compete more effectively than we can, resulting in a loss of our market share and a decrease in our net revenue and profitability.

Result: All of that has happened. Rivals like Athleta, a chain operated by the Gap, have capitalized on Lululemon’s struggles, opening up dozens of new activewear stores and undercutting it on price. And lastly?.?.?.

Risk: Our inability to maintain recent levels of comparable store sales or average sales per square foot could cause our stock price to decline.

Result: Just take a look at the chart on this page. This was perhaps the most important red flag Lululemon could have waved.

The new CEO, Potdevin, will need to perform an almost gravity-defying feat of leadership to turn the retailer around. As the former head of Toms Shoes, famous for donating one pair of shoes for each pair it sells, analysts say he’s a good fit for Lululemon’s corporate culture. But it’s simply not clear the chain’s downward trajectory can be reversed.

Investors often accuse companies of hyping their stock—of issuing projections that are too rosy, or being overly optimistic about the outlook for their industries. But companies are also required to lay out the risks they face, and they do. It’s then up to investors to read and understand them. Those that don’t have only themselves to blame.