Luxury lifestyle company Ralph Lauren (NYSE:RL) is scheduled to report its Q3 fiscal 2014 results on February 5, 2013. We expect the company to post modest growth of around 7-8% as currency headwinds will impact its top-line growth. Profits are expected to remain constant as a lower gross margin is essentially offset by operating expense leverage. On the business segment front, we expect the wholesale channel to outperform the retail channel, as the latter is extremely sensitive to currency impacts owing to its highly diverse geographic mix.
We expect Ralph Lauren’s top-line growth to accelerate in the long run due to its growth strategies such as expansion in the retail footprint, e-commerce channel, and new product categories (such as Denim & Supply and accessories). In addition, a more comparable base will boost RL’s top-line growth as it laps the discontinuation of its several businesses in the future.
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Recap of Q2 fiscal 2014 results
Excluding the impact of store closures in China, discontinued businesses and unfavorable currency translations, revenue grew by about 4% annually in Q2. Sales grew 3% in the second quarter, which was at the high end of the company’s expectations. Gross margins declined by 220 basis points annually to 56.6% because of unfavorable foreign currency dynamics, the mix impact from integrating the Chaps men’s sportswear business and lower profits from concession shops. Operating margins also fell by 330 basis points, due to a 6% rise in operating expenses. The higher operating expenses reflected cost associated with newly transitioned operations and continued investment in the company’s strategic growth initiatives. Geographically, the gains made in the Americas, Europe and most of Asia were partially offset by a weak Japanese Yen.
High Revenue Growth Expected In The Second Half Of Fiscal 2014
In the Earnings Call of Q2 Fy14, the company’s CFO Christopher H Peterson said, “Based on the timing of our specific projects, we’ve characterized fiscal 2014 as a tale of 2 halves, with modest sales growth and outsized investment spending in the first half of the year, transitioning to accelerated revenue and profit growth in the second half of the year.”
He cited three key drivers supporting the company’s revenue outlook: 1) expected growth in wholesale orders for the back half of the year, 2) improved contribution from recently transitioned stores in Australia and New Zealand, and 3) strong customer response to the fall assortments in both wholesale and retail channels.
Wholesale Outlook Strong
Wholesale revenues grew 1% to $928 million in the second quarter. Growth was primarily a result of the contribution from the newly transitioned Chaps men’s sportswear operations and continued growth in North American merchandise categories, which continue to gain market share. Lower Japanese wholesale sales and supply chain challenges partially mitigated wholesale revenue growth during the quarter. These factors meant that operating income fell by 12% on a year-on-year basis.
Growth in Ralph Lauren’s wholesale channel sales has lagged behind that of its retail segment in the past few quarters owing to the company’s strategy to expand its direct-to-consumer business. However, we expect the recently integrated Chaps sportswear business from a licensed business to a directly managed wholesale business to boost revenue growth for wholesale channel. In addition, currency headwinds are expected to impact the retail segment in a more pronounced manner compared to the wholesale channel in Q3 fiscal 2014. For these reasons, we expect the wholesale segment to outperform overall sales growth for the company in Q3.
Retail Segment Growth Expected To Be Slow
Retail segment sales rose 5% to $944 million in the second quarter, outpacing the company’s overall growth and the growth in the wholesale segment. This high growth was a reflection of the incremental contribution from new stores, including the recently transitioned Australia/New Zealand operations, and growth for the company’s e-commerce operations. Excluding currency impacts, retail sales grew by 8% on a year-on-year basis.
However, retail operating income of $135 million was 14% below the figure from the same period of fiscal 2013. This was primarily due to investments in the company’s global store and e-commerce development efforts, foreign currency effects and lower profitability at concession shops. Moreover, the retail business owing to its business being spread out in various geographies is extremely sensitive to macroeconomic factors and currency headwinds. In Q2, growth in the Americas, Europe and most of Asia was significantly offset by currency issues in Japan. We expect the same trend to continue in the third quarter.
Our price estimate for Polo Ralph Lauren stands at $174, implying a premium of around 10% to the market price.