All eyes on margins ahead of Lululemon earnings

Investors will be scrutinizing inventory and margins when Lululemon Athletica reports its third quarter earnings on Wednesday, as fears mount that competitors are eroding the yoga wear-maker's share of the lucrative athleisure market.

Once the darling of the retail space, the Vancouver-based company has struggled in recent years with a series of mishaps, from a high-profile recall of overly sheer yoga pants in 2013 to supply chain hiccups that led to bloated inventories this year.

In September, executives reassured investors that the supply chain issues had been resolved, but noted that inventories would stay elevated as late spring and summer products joined fall and winter inventory on shelves.

That added inventory led to extra warehouse sales, and many analysts expect that sales in the third quarter will be driven by markdowns, putting more pressure on gross margins.

Add in tougher competition from the likes of Nike and Under Armour, who are creating innovative products that tend to sell at a slightly lower price point, and the company could be facing an upward battle against narrowing margins.

"It's going to be tough for them," said Susan Anderson, an analyst with FBR Capital Markets & Co. "I think they have to keep their brand's image and their quality up to justify their really high price points."

Analysts also highlighted expensive air freight as a potential sore spot, with production delays leaving the retailer dependent on shipping by plane.

"Air freight costs you $2 to $2.50 per garment ... versus 40 cents for putting it on a boat," said Christian Buss, an analyst with Credit Suisse, adding the company has said it ships 40 to 50 percent of product by air, while the industry average is less than 15 percent.

But Buss was positive over the long-term, saying he expects Lululemon to cut back air freight to about 25 percent over the next 18 months, which would help strengthen margins.

Investors will also be focused on operations, looking for signs the company is investing in technology to keep production running smoothly and on time.

"They need to continue to invest in innovation and brand management, while refining processes to manage inventory and other business controls to build efficiency," said Bruce Winder, a partner with Retail Advisors Network.

Shares of Lululemon closed up 0.7 percent at $52.16 on Tuesday, well below its year-high of $70 per share in mid-April.