Earnings Review: Incremental Investments Beginning To Reap Dividends For Ralph Lauren

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RL: Ralph Lauren logo
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Ralph Lauren

Luxury lifestyle company, Ralph Lauren (NYSE:RL), posted better-than-expected earnings in the first quarter of fiscal 2015. The retailer posted year-on-year net revenue growth of 4% for the quarter, with the retail segment driven by a direct-to-consumer strategy leading the growth. [1] Operating margin was 100 basis points below last year’s figure of 14.4%, but still higher than guided for by the company. Due to the timing of payments related to incremental investments in growth initiatives, the company was expecting a lower margin but operational discipline and the favorable impact of currency fluctuations helped it achieve a better margin. [2] As a result of challenges facing the company’s wholesale segment and the weak retail environment in the U.S., RL lowered its guidance for fiscal 2015. The company now expects to grow its revenue by about 5-7% for the full year on the back of store expansion, e-commerce operations and investments to support the launch of the Women’s Polo line, implying a downgrade of about 100 basis points.

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.

See our complete analysis for Ralph Lauren

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Retail Sales Lead Top line Growth

Retail sales increased by 7% during Q2 fiscal 2015, driven by double-digit growth in international operations and global e-commerce business, and global store expansion. ((Ralph Lauren Q1 FY15  Earnings Call Transcript, Seeking Alpha, August 2014))  Retail segment operating margin was 13.6%, 80 basis points below that in the prior year period. The drop in margin reflected the company’s expenditures on its global store and e-commerce development efforts, in addition to increased investments in advertising and marketing. Excluding those incremental investments, RL’s  retail profitability improved from the prior year’s level because of its strong international performance. [2]

Wholesale revenues increased by 2% to $943 million. Profitability was unaffected in this segment over the quarter as operating margin was flat as the increased profitability of underlying operations was offset by incremental expenditures in advertising and marketing. [2]

Future Growth Drivers

Looking ahead, RL remains committed to three key initiatives that it believes will drive sales and profits over the next three to five years.

  • The company has intensified the development of its Polo brand. Currently, 60% of the sales made by the company are in its men’s business, the reverse of the usual industry trend where sales are skewed towards women. During fiscal 2014, the company created Polo for women, which it expects to replace the existing Blue Label line for women. Therefore, the sales made from this switch will not be completely incremental. However, in the longer term the company expects the Polo brand to address a much broader market than the Blue Label line. Additionally, the retailer is still in the early stages of executing the expansion of its Polo stores worldwide. It operates 13 Polo stores currently, with plans of opening 15 to 20 more in fiscal 2015. Over the long term, the company believes there is an opportunity to have between 100 and 200 Polo stores worldwide, with a significant concentration in international markets. [3]
  • The second initiative involves the development of the e-commerce segment. In fiscal 2014, e-commerce brought $500 million in revenues. Based on the high growth and the profit creative dynamics of the channel, the retailer will continue investing in this space. At present, the company’s e-commerce operations behave very differently in different geographies. In the U.S., the management pointed out that if a consumer switches from shopping at a brick-and-mortar store to online, it is profitable for the company. However, the company’s e-commerce operations are only starting to achieve scale in Europe. RL will need to make further investments in its European e-commerce business to reach the same level of profitability as in the U.S. Meanwhile, it’s only just launched the e-commerce business in Asia. The company currently operates in Japan and Korea, with investments still ongoing to bring operations online in Greater China and Southeast Asia.((Ralph Lauren Q2 FY15 Earnings Call Transcript, Seeking Alpha, October 2014))
  • The third initiative involves accessories in general and leather goods in particular. The retailer converted footwear from a licensed to owned segment in 2006 and re-opened operations in 2008. At the same time, the company gained direct control of its licensed handbags and small leather goods business. Since then, the leather goods category has grown at an average of 20% annually. Currently, handbags, footwear and leather goods represent less than 10% of total consolidated sales. The company has stated that it wants to grow this category to about 20% of the top-line, which should favorable margin implications as it is a higher margin category than apparel. [2]

We are in the process of revising our price estimate for Polo Ralph Lauren, which stands at $174, implying a premium of around 10% to the market price.

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Notes:
  1. Polo Ralph Lauren Investor Relations SEC Filings []
  2. Ralph Lauren Q2 FY15 Earnings Call Transcript, Seeking Alpha, October 2014 [] [] [] []
  3. Ralph Lauren’s Q4 2014 Results Earnings Call, Seeking Alpha, May 2014 []