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Lululemon Athletica Inc.'s famous yoga pants can stretch a long way before they look unsightly, but they do have their limits. So, too, does the company's stock.

After a remarkable run that saw the stock of the Vancouver-based athletic-apparel retailer nearly triple in eight months, the shares have gone into a serious funk. As the company prepares for this week's annual meeting (Wednesday in Vancouver) and fiscal-first-quarter earnings release (Friday), it is suddenly less a high-flying stock-market darling than an overstretched stock in an out-of-favour sector.

"It seems that Friday's earnings report could be a crucial moment for the struggling stock," said analyst Sarah Wasserman of Cincinnati-based Schaeffer's Investment Research in a report this week.

"The stock appears priced for perfection, and we believe any glitch on earnings could result in a selloff," wrote analyst Liz Dunn of FBR Capital Markets in New York, who last week downgraded the stock to "underperform." "We believe the market will punish anything other than a flawless quarter, given [Lululemon's]valuation and recent run."

Lululemon hit an all-time high of $97.50 on the Toronto Stock Exchange in April - not long after no less authority than popular CNBC stock-picker Jim Cramer endorsed the stock, calling it a "high-octane secular growth story" - and as recently as two weeks ago it was above $95. But since then, the shares have gone into freefall, amid growing concern about the state of the U.S. economy and a string of disappointing May sales results from major U.S. retailers. The stock has dropped 15 per cent in the past nine trading days.

"About three-quarters of that is market-related," said analyst Andrew Burns of D.A. Davidson & Co. of Lake Oswego, Ore. He said a disappointing May U.S. retail sales - which he blamed largely on unseasonably cool weather in the Northeast - has rattled investors in the sector. However, he added, "There is some concern around the first quarter."

Meanwhile, the sharp rise in price since last summer has made analysts increasingly wary about the stock's attractiveness. Based on analysts surveyed by Bloomberg, the stock now carries a below-average consensus recommendation, with the Street split on its opinion: Six analysts rate the stock a "buy" versus five who rate it a "sell," with 10 "hold" recommendations.

'Very Lofty Numbers'

Despite the recent pullback, Lululemon still looks expensive relative to its peers - a consequence of its strong historical growth and its tendency to beat the Street's quarterly earnings estimates. Davidson's Mr. Burns noted that the shares are trading at a price-to-earnings multiple of about 32 times and an enterprise-value-to-EBITDA multiple of 18 times, based on forecast earnings for the current fiscal year.

"Those are still very lofty numbers," he said, noting that the stock is still a touch rich even when compared with other "premium high-growth consumer stocks."

Given the big valuation and investor nervousness surrounding the retail sector, analysts say Lululemon's stock could be punished further if its results for the first quarter ended April 30 don't live up to expectations.

The key, analysts say, is how much Lululemon's recent inventory problems constrained growth in the quarter. The company disclosed when it released its fourth-quarter results in March that it was suffering from shortages of supplies of its apparel - partly due to high demand, and partly due to the transition of its online retail business from a third-party provider to an in-house operation.

Rising Costs

Ms. Dunn of FBR Capital Markets said the company's efforts to replenish inventory may have pushed up its costs - putting pressure on its profit margins.

"We believe the company is hesitant to raise prices and remains very focused on maintaining product quality. We believe Lululemon will move to preserve quality at the expense of margins," she wrote. "While this is absolutely the right thing to do in the long term, in the near term the margin ramifications may pressure the shares."

"This is a company that has put up incredible [earnings forecast]beats," said Mr. Burns, who has a neutral rating on the stock. "Now it faces a quarter where its operational abilities have been limited."

Longer term, he believes, Lululemon is "a phenomenal growth story." However, the company's past successes have set a very high bar for the stock to clear.

"In order to justify further share appreciation, [quarterly]results need to surpass already-aggressive investor expectations."

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