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Despite niche appeal, Lululemon can’t escape sector’s headwinds

The realities of the crowded retail landscape have finally caught up to Lululemon Athletica Inc. The Canadian yoga-wear peddler warned Monday that it would fall well short of its original earnings estimate of 78 to 80 cents (U.S.) a share for the fiscal fourth quarter.

The revised range of 71 to 73 cents would put profit below the level of a year earlier. That's never a good sign for a story stock whose compelling theme – at least before last year's woes – had been all about rapid growth of a strong, near-iconic retail brand with a loyal and widening customer base.

But the latest bad news to rock the stock is only partly about Lululemon. It's also about tough market conditions for many apparel purveyors.

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One big problem is that the old, reliable American shopaholic, the backbone of just about every U.S. recovery and growth surge, has only showed up sporadically since the end of the Great Recession, despite falling debt levels and rock-bottom interest rates. Four years into a sputtering recovery, fear – of job losses and financial reversals – still appears to trump confidence, even as housing prices have gained ground and job prospects have improved in several key U.S. markets.

The result has been lower mall traffic and weaker spending across much of the retail spectrum. And now even the once-unscathed luxury corner of the mall – where Lululemon has positioned itself – is getting hit. Upscale apparel-maker Burberry, for example, saw profit margins and return on capital shrink in fiscal 2013.

All of this is occurring at a time when major U.S. department store chains like Macy's (which last week announced the closing of five stores and the layoffs of 2,500 employees) are retooling to lure more upscale shoppers, and broad apparel retailers like Gap Inc. and H&M are expanding into Lululemon's arena through new product lines, branded chains and acquisitions.

To be sure, Lululemon has some issues that are uniquely its own. Its growth story got sidetracked last spring when the company's infamous see-through fabric fiasco exposed a serious flaw in its supply chain. And the operational concerns were compounded by the subsequent exits of senior people, including chairman and founder Chip Wilson, who poured oil on the smouldering PR fires by suggesting that some women's bodies were unsuited to the company's workout wear.

It didn't help that the stock had been inflated for too long by unrealistic expectations. It was trading at 30 times trailing earnings before the latest bad news, down from a ridiculous 80 times in early 2012. It was long past time to scale back those other-worldly expectations in a competitive, slow-growth environment.

At a more reasonable valuation, Lululemon may still be an attractive stock. Faced with formidable sports gear competitors like Nike Inc., it has managed to craft a strong brand based on high-quality, environmentally friendly products that is wrapped in an increasingly popular aura of fitness, fashion and youthful vigour.

This story should remain intact, despite the gaffes of last year. But that doesn't mean Lululemon has any special immunity to the stresses and strains faced by other retailers across the entire spectrum of price and quality. Stock market players are finally coming to grips with this painful reality.

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