Earnings Preview: Retail Division To Drive Ralph Lauren’s Top Line But Rising Expenses Could Limit Impact On Profits

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Ralph Lauren

Luxury lifestyle company Ralph Lauren (NYSE:RL) is scheduled to report its Q3 fiscal 2015 results on February 4. We expect the company’s revenues to grow at a lower rate of around 3-5%, in line with the 4% growth in the second quarter. The company’s retail operations should grow more than its wholesale operations, where sales are likely to be flat with last year’s level. RL’s operating margin for the first quarter is expected to drop by around 2% compared to the third quarter last year, primarily due to higher operating expenses related to the timing of investments to support the company’s growth initiatives. In fiscal 2015, RL focused on its long-term growth objectives which include extending its direct-to-consumer reach through company-owned stores and the e-commerce channel, expanding its international presence and developing the infrastructure to support that presence, and investment in new products and merchandise. These initiatives are expected to put pressure on the company’s bottom line as selling, general, and administrative expenses, and capital expenditures, should rise.

We expect Ralph Lauren’s top line to continue to grow as markets such as China and India are set to increase their spending on luxury items by 80% and 72% respectively over the 2013-2018 period. In addition, we expect the company to acquire a more comparable base to boost its top line growth, as it discontinues unproductive businesses and streamlines its supply-chain arrangements.

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Recap Of Q2 Fiscal 2015 Results

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. As a result, the company lowered its revenue projection for the full fiscal year 2015 to about 5-7%, implying a downgrade of about 100 basis points.

For the full year fiscal 2015 period, the company guided for consolidated revenues to increase by 6% to 8%, led by retail segment growth. We expect RL’s fiscal 2015 operating margin to fall about 1-2% below fiscal 2014 level, due to investments in its strategic growth initiatives and infrastructure. The higher level of investment is reflected in the company’s capital spending plans. RL is planning approximately $400 million to $500 million in capital expenditures in fiscal 2015 to support its global direct-to-consumer and infrastructure investments, as well as wholesale shop development for the women’s Polo launch. [3]

Wholesale Outlook Stable

Wholesale revenues grew 2% to $943 million in the second quarter. [4] Future growth for the wholesale division will be driven by the core North American sales, where the company continues to gain market share, the addition of Chaps menswear to the company’s operations, and improved trends in Europe. Profitability is expected to improve in this segment due to lower freight and transportation forecasts as a result of lower oil prices, but their impact should be offset by the negative impact of foreign currency translations. Growth in Ralph Lauren’s wholesale channel sales had 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 think that RL has maxed out its growth potential in this segment. We expect revenue from sales to be at about the same level as last year. Any gains to the bottom line will have to come from reduction of costs and the elimination of operational inefficiencies.

Retail Segment Growth Expected to Pickup

Retail segment sales rose 7%  in the second quarter, driven by double-digit growth in international operations and global e-commerce business, and global store expansion. [4]  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. [4] In the third quarter, we expect the same trends to continue. The addition of new stores and the Polo for Women line should also contribute strongly to the top line. However, the impact of expenditures related to the addition of new stores and maintenance of store operations, should limit the impact of increased revenues on the bottom line.

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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 []
  4. Ref:2 [] [] []