Ralph Lauren (NYSE:RL) is a global leader in the design, marketing and distribution of premium lifestyle products. Its products include apparel, accessories and fragrance collections for men and women as well as children’s wear and home furnishings. The company’s brands such as Ralph Lauren, Club Monaco, and Polo are some of the world’s most widely recognizable consumer brands.
According to our analysis, the company’s retail segment is its most valuable division, contributing more than half of its value. In the third quarter of Fiscal 2014, retail segment sales rose 6% to $1.1 billion. The growth was a reflection of the incremental contribution from new stores and comparable store sales growth. Excluding the impacts of discontinued businesses and negative foreign currency effects, retail sales increased 10%. Comp growth was primarily driven by strong global e-commerce performance. 
We explain below how the retail segment has gradually overtaken the wholesale segment as the biggest contributor of value to the company and why it is likely to remain so.
Wholesale vs. Retail Business
Wholesale and retail are the two main business segments of Ralph Lauren, accounting for about 96% of its revenues. About 57% of the company’s revenue comes from the retail segment, and the wholesale segment constitutes about 39%. Under the wholesale segment, apparel and accessories are sold at more than 11,000 doors globally while Ralph Lauren operates around 500 retail outlets. 
The wholesale business’ contribution to overall revenues has been declining since 2008. It stood at 58% of total revenues in 2008 and 39% in 2013. On the other hand, the retail segment improved from 39% to 57% during the same period. We believe this trend will continue in the future with wholesale’s contribution coming down to as low as 30%.
There are two reasons for this shift:
- Ralph Lauren is planning for aggressive expansion in international markets, which will boost its retail business.
- The department stores’ market share has been declining in the U.S. retail market and this is likely to continue. The increasing competition from private label brands at department stores is also a concern for retailers. With the increase in the share of private label brands, Ralph Lauren’s specialty stores and other department store revenues have been impacted. Other factors such as the discontinuation of American Living brand and consolidation of China network (to add retail stores) have also weighed on the wholesale segment’s growth.
Although revenues from the wholesale segment is likely to grow, we expect growth to be slower than the retail segment. This will facilitate the decline of revenue contribution of the wholesale segment and an increase in the retail segment’s revenue contribution. With operating margins for the two segments roughly being the same, cash profits will witness a similar trend. This justifies the huge difference in valuation for the two segments.
Ralph Lauren discontinued the Rugby brand in fiscal 2013, as it had been losing out on market share to competitors such as Michel Kors ( Kors ) and Tory Burch. Store traffic had been decreasing and the company decided that it can cater to Rugby’s customers through its other brands such as Denim & Supply and Club Monaco. Moreover, going by statements made by the management over the last few earnings call, Ralph Lauren wants to focus on global opportunities for its other brands rather than U.S. centric Rugby. 
At the end of fiscal 2012, Ralph Lauren operated 16 Rugby stores, out of which 13 were in the U.S. Compared to Rugby, Ralph Lauren’s other brands have a much better presence in international markets. For instance, at the end of fiscal 2013, the retailer operated around 59 Ralph Lauren retail stores and 65 factory stores in Europe and Asia. Its Club Monaco brand also has an international footprint via the licensing channel. These brands have performed quite well with Ralph Lauren retail, factory stores and Club Monaco registering comparable store sales growth of 8%, 13% and 18% respectively in fiscal 2013. 
Ralph Lauren’s focus on global markets is evident from the fact that out of the 47 factory stores opened in the last five years, 38 were in international markets. Similarly, it opened 20 Ralph Lauren retail stores internationally while it consolidated 15 stores in the U.S. International markets such as Asia have proven to be quite lucrative for the U.S. apparel retailers. For instance, in China, the initial stores of retailers such as Abercrombie & Fitch ( ANF ) and Gap ( GPS ) have performed well. Additionally, Luxury retailer Coach ( COH ) reported 25% growth from the region in its latest earnings. Ralph Lauren has been expanding its presence in the Asian markets. It had 16 Ralph Lauren retail stores and 23 factory stores in 2012, but now has 32 Ralph Lauren retail stores and 25 factory stores in the continent. 
Another key driver to watch here is the company’s e-commerce division. 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. 
Our price estimate for Polo Ralph Lauren stands at $174, implying a premium of around 17% to the market price.Notes:
- Polo Ralph Lauren Q3 FY14 Earnings Call Transcript [↩] [↩]
- Ralph Lauren Investor Relations [↩] [↩]
- Ralph Lauren Bids Farewell To Rugby, Telegraph, November 2012 [↩]
- Coach Earnings Call Q2 FY 14, Seeking Alpha, February 2014 [↩]