Luxury lifestyle company Ralph Lauren (NYSE:RL) posted better-than-expected earnings in the second quarter of fiscal 2014 (fiscal year ends March), which contributed to about 5% rise in its stock price on the following day. The retailer posted net revenue growth of 3% annually to $1.9 billion. Excluding the negative impact associated with foreign currency translation and discontinued businesses, sales increased by about 4%. The company also raised its top-line outlook for the entire fiscal year to 5% to 7% growth year to year, as compared to its initial estimate of 4% to 7% growth. The revenue outlook for the third quarter is also positive, as RL expects net revenues to rise by 8% to 10% during the holiday quarter.
The company’s profitability declined during the quarter, due to adverse currency effects, the integration of the previously licensed Chap’s men’s sportswear businesses, and higher investments in the company’s growth strategies. The gross margin declined by 220 basis points annually to 56.6% and operating margin fell by 330 basis points to 15.4%. While the drop in profitability looks disappointing, it is the result of strategic initiatives and (importantly) in line with the previous guidance. RL’s management revised its operating margin outlook for fiscal 2014 downwards, to the lower end of its previously forecast 25-75 basis-point decrease from the prior year’s margin of 16.2%. In other words, the operating margin guidance is now effectively closer to 15.5% than 15.7%
We believe that the company’s revenue growth can accelerate going forward, benefiting from a variety of growth strategies discussed below. We also expect the company’s profitability to improve over the longer term, as investments in these growth strategies bear fruit. Efficiencies gained through the improvement of its management information systems should contribute as well.
Growth In Retail Sales Outpaced Wholesale Sales
Retail sales increased by 5% during Q2 fiscal 2014 due to the contribution from new stores, recently transitioned operations in New Zealand and Australia, and strong sales growth in the e-commerce channel. Retail sales rose by 8%, excluding the effect of discontinued operations and adverse currency changes. Comparable store sales decreased by 1% in dollar terms, and increased by 1% in constant currency terms. We will continue to track this metric in the future, as the traffic trends at brick and mortar stores continued to be soft during the quarter.
Wholesale revenues rose by a less impressive 1%, due to a mix of positive and negative factors. On the positive side, the company benefited both from the impact of the transition of Chap’s men’s sportswear businesses and from increased sales in North America. This was offset to a degree, however, by reduced shipments to certain European wholesale partners and a decrease in Japanese wholesale sales. Changes to the SAP management information system also had a negative impact, as some wholesale shipments were delayed during the quarter.
RL estimates that wholesale revenue growth will exceed retail sales growth during the third quarter of the fiscal year, as the impact from currency fluctuations will be higher on the retail segment.
Future Growth Drivers
We believe RL’s strategic growth drivers will continue to fuel its growth in the future. The company has expansion programs underway in each of three areas: 1) in international operations; 2) in the direct-to-consumer channel; and, 3) in selected product categories .
Ralph Lauren currently generates roughly two-thirds of its revenue from Americas, and around 20% from Europe, and the remainder from Asia. Through International expansion, management intends to change this revenue distribution to one-third from each region. To achieve this goal, it is targeting both existing markets abroad for greater penetration, as well as new markets that include Greater China and Central & Eastern Europe.  And it plans to optimize the blend of retail and wholesale locations country by country to best leverage local conditions.
Similarly, RL is enhancing its retail channel by opening more stores and serving more countries through the e-commerce channel. During the second quarter, the company expanded its e-commerce distribution facility in North America and initiated e-commerce sales in South Korea.
Finally,with regard to expanding selected product categories: Management aims to grow the accessories business with new merchandise categories, including handbags, footwear, eye wear, watches and fragrances. Handbags, small leather goods, and footwear accounted for about 8% of the company’s revenue in fiscal 2013, and we expect this proportion to increase over the long run. 
We are in the process of revising our price estimate for Ralph Lauren’s stock.Notes:
- Ralph Lauren Management Discusses Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, November 6, 2013 [↩]
- Ralph Lauren Management Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, August 7, 2013 [↩]