Luxury lifestyle company Ralph Lauren (NYSE:RL) recently posted net revenue growth of 4% annually in its first quarter of fiscal 2014 and gave a more modest outlook for the second quarter. We have updated our model accordingly and the price estimate for the company is now $177 per share, rather than the prior $187. This represents a decrease of about 5%. In this article, we outline some of the key factors that drive our new price estimate.
We have forecast more moderate revenue growth for the company over our forecast horizon. Expansion of direct-to-consumer and wholesale channel will help drive its revenue growth. However, discontinued businesses and adverse currency rates will negatively impact year-over-year top line growth in the short term. While we expect the profitability to decline in 2013, we believe it will increase over the long run. We encourage our readers to test estimates in their own models to see the impact on the company’s valuation.
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Top Line Growth Expected To Grow At A Moderate Rate
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Though we have lowered our near-term estimates a bit, we still expect Ralph Lauren’s top line to grow at around 6% over the next two calendar years, driven by increased sales in both the direct-to-consumer and wholesale channel. We have restructured the company’s model to include the following segments: 1) the Retail segment; 2) the the Specialty Stores and Other Department Stores segment (excluding Macy’s); 3) the Macy’s Department Stores segment; and, 4) the Licensing Royalties segment. In our model the first two segments contribute more than 80% of the value of the company ‘s stock.
The retail segment, accounts for more than 50% of our valuation, and we have included the following as key drivers of revenue growth:
- Average Revenue Per Square Foot: This represents the average revenue achieved per square feet within RL’s directly operated stores. This has been calculated by taking the total revenue achieved within the retail channel and then subtracting the revenue derived through e-commerce sales and concession-based shop-within shops. Then, we divide this figure by total square feet for company locations to get the value for revenue per square feet.
- In 2013, we have estimated this figure to grow by only 1% owing to lower traffic at stores, and currency devaluation in Japan and other markets of Asia. Over the long run, we have forecast this metric to grow by around 2.5%. Strong growth in Americas, recovery in the European market and expansion in Asia will help fuel revenue growth over our forecast period.
- Average Square Footage per Store: We calculate this figure as total square footage divided by the number of directly operated freestanding stores. We expect this metric to rise slowly during our forecast period. Since Ralph Lauren aims to open several premium stores around to world to elevate its brand image, we believe this strategy will result in expansion of this metric over the long run.
- Number of Freestanding stores: As Ralph Lauren aims to expand its direct-to-consumer footprint by opening more factory stores, Club Monaco stores and dedicated Polo stores, we believe this figure will rise over our forecast period.
- E-commerce Sales: RL’s e-commerce sales have grown at a strong rate over the past, as the company has expanded this channel to cover various markets of Asia and Europe. We expect this metric to grow at a healthy rate in the future as the company continues to invest in expanding this channel. Increased traffic at RL’s e-commerce sites will help drive these sales, as well.
- Within the wholesale segments, we expect the revenue from Specialty Stores and Other Department Stores segment (excluding Macy’s) to rise over our forecast period. The recent integration of Chaps sportswear business from a licensed business to a directly operated wholesale operation will boost the revenue growth in this segment over the short run. The continued growth in Americas along with recovery in the European region will also help drive this metric.
- We think the revenue from Macy’s Stores segment will also grow at a healthy rate in the future, driven by strong growth in the Americas region and expansion into new product categories such as handbags, footwear, eye wear, watches and fragrance.
Profitability Could Decline In The Short Term
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We expect RL’s EBITDA margin to decline in 2013 on account of accelerated investments in growth strategies (which includes retail store expansion, e-commerce capabilities, and change in management information systems), integration of new businesses and adverse currency impact. However, over the long run, we expect increased efficiency and procurement savings to result in higher profitability.
Capital Expenditure and Tax Rate Forecast
While we expect capex as a percentage of revenue to rise in 2013 due to accelerated investments in growth strategies, this figure should come down in the future as more typical patterns of investment return.
Finally, we have forecast an effective tax rate of 31% over our forecast period, in line with the historical trend and the company’s guidance. The increasing proportion of international revenue in overall revenue will exert downward pressure on this metric over time.
Our $177 price estimate for RL’s stock, represents near 5% upside to the current market price.