Luxury lifestyle company, Ralph Lauren (NYSE:RL), posted better-than-expected earnings in the third quarter of fiscal 2014 (fiscal year ends March). However, its stock fell by ~4% following the earnings announcement. The retailer posted net revenue growth of 9% annually to $2 billion.  Excluding the negative impact associated with foreign currency translation and discontinued businesses, sales increased by about 11%. The company also raised its top line outlook for the entire fiscal year to 7% growth year-on-year, compared with its initial estimate of 5% to 7% growth. The revenue outlook for the fourth quarter is also positive, as RL expects net revenues to rise 2% faster than its prior projection of 8% to 10%.
The company’s profitability declined during the quarter, due to adverse currency effects and integration of the Chaps menswear operation. This was partially offset by strong growth in the core business. The gross margin declined by 110 basis points annually to 58.2%. Strong operational efficiency saw operating expenses drop by 120 basis points to 41.6%, resulting in an operating margin of 16.6%, 10 basis points higher than the management’s previous expectation. RL’s management revised its operating margin outlook for fiscal 2014 downwards. The margin is expected to drop 110-120 basis points, lower than 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 15.2% than 15.7% 
We believe that the company’s revenue growth can accelerate going forward, benefiting from a variety of growth strategies we discuss below. We also expect the company’s profitability to improve over long term, as investments in these growth strategies bear fruit. Efficiencies gained through the improvement of its management information systems should contribute as well.
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- Why Did We Revise Our Price Estimate Of Ralph Lauren To $102?
Growth In Retail Sales Low As Expected
Retail sales increased by 6% during Q3 fiscal 2014 due to the contribution from new stores in New Zealand and Australia, and strong same-store sales growth.  The Retail Sales segment, owing to its geographical business mix, is more exposed to currency headwinds than the Wholesales channel. For this reason, growth in this segment was lower than the overall growth experienced by the company. We will continue to track this metric in the future as this is a critical growth area for the company. If revenues from international stores rise enough to have a meaningful contribution to growth despite currency impacts, there could be significant upside to RL’s stock valuation.
Wholesale Outpaced Company Growth
Wholesale revenues rose by an impressive 14% to $840 million. This strong growth was driven by the strong momentum in core North American sales, where the company continues to gain market share, the addition of Chaps menswear operations and improved trends in Europe. Profitability also improved in this segment as operating margin was up 20 basis points due to strong profitability in the core operations. This was partially offset by the expenses incurred in the integration of the Chap’s menswear line. 
RL estimates that wholesale revenue growth will continue to outpace retail sales growth during the fourth 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 the drivers : 1) international operations; 2) direct-to-consumer channel; 3) selected product categories.
Ralph Lauren currently generates roughly two-thirds of its revenue from Americas, 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 existing markets abroad for greater penetration, as well as new markets that include Greater China, and Central and Eastern Europe. It also 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 last decade, the e-commerce channel has grown at a CAGR of 25%. This is impressive as the channel is still in its nascent stages in both Europe and Asia. In time, as the company moves from investment stage to achieving economies of scale in these regions, it should contribute to high growth for the company. 
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 year 2013, and we expect this proportion to increase over the long run.
We are in the process of revising our price estimate for Polo Ralph Lauren, which stands at $174, implying a premium of around 17% to the market price.