Shares of Lululemon (LULU) fell as much as 12 per cent on Monday after the company said it expects profit margins to drop in the fourth quarter.
In a press release, the Vancouver-based company says it expects gross margins to decline by between 0.9 and 1.1 percentage points in its upcoming fiscal quarter. Lululemon had previously forecast that gross margins – the amount of profit made on goods measured as a percentage – would increase slightly by between 0.1 and 0.2 percentage point. Last year's gross margin in the fourth quarter was 58.1 per cent on US$1.2B in profit.
Lululemon's stock ended the trading day on Monday at $298.66, a decline of 9 per cent compared to Friday's close.
While Lululemon did not provide details about what is driving margins down, many retailers have grappled with profit challenges amid bloated inventory levels and an inflationary environment that has put pressure on sales.
Lululemon has already seen profit margins under pressure. In the third quarter, the company's gross margin level fell 1.3 percentage points compared to 2021, due in part to larger markdowns.
Jefferies analyst Randal Konik said in a research note on Monday that the earnings revision shows that gross margins have "peaked and sales upside is waning" and that markdowns are rising and will continue in 2023 given heavy inventory levels.
"Looking ahead, we see dark clouds forming with difficult compares, peak margins, high inventory and rising competition," Konik wrote.
"Elevated promotional activity and markdown risk are likely to weigh on margins going forward."
Lululemon chief executive Calvin McDonald told analysts on the company's last quarterly conference in December that the brand is "comfortable" with its inventory levels, saying 45 per cent of its total stock includes its "core styles" that have limited seasonal markdown risk.
"Our inventory levels were too lean last year, and we made the strategic decision to build inventories this year, which enabled the strong top-line growth we have delivered," McDonald said in December.
The cut comes as Lululemon hikes its sales forecast amid strong holiday traffic. Net sales are now expected to be in the range of between US$2.66 billion and US$2.7 billion, an increase of between 25 per cent and 27 per cent compared to the same quarter last year. The previous forecast was between US$2.605 billion and US$2.655 billion.
Lululemon will report its fourth-quarter earnings in March.
Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.