Earnings Preview: Investments In Growth Initiatives Could Hurt Ralph Lauren’s Bottom Line

Luxury lifestyle company Ralph Lauren (NYSE:RL) is scheduled to report its Q4 fiscal 2015 results on Wednesday, May 13. We expect the company’s revenues to grow at a lower rate of around 3-5%, slightly higher than the 1% growth in the third 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 fourth quarter is expected to drop by around 2% compared to the fourth 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 Q3 Fiscal 2015 Results

In the third quarter, the retailer posted year-on-year net revenue growth of 1% helped by a double-digit sales expansion in international sales and e-commerce business. ^[1] Operating margin was 110 basis points below last year’s at 15.5%, but still higher than guided for by the company. Due to the timing of payments related to incremental investments in growth initiatives such as store expansion, infrastructure, and marketing, 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 the challenges faced by the company’s wholesale segment over the quarter, and the weak retail environment in the U.S., RL lowered its guidance for fiscal 2015 by 2 percentage points. The company expects to grow its revenue by about 4% 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.

We expect RL’s fiscal 2015 operating margin to fall about 1-2% below the 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

In the third quarter, wholesale revenues were roughly flat at $837 million (a 2% increase on a constant currency basis). This was due to a shift in the size of shipments between the second and third quarters, slightly offset by the incremental revenues added by the Chaps menswear operations. Combining wholesale revenues for the first three quarters, wholesale revenue were roughly flat, reflecting the impact of foreign exchange and a weak macro environment faced by RL in North America and Europe. Profitability also suffered in this segment over the quarter, as operating margin was down 120 basis points due to the fixed costs associated with shipments and the unfavorable impact of currency fluctuations. 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 the reduction of costs and the elimination of operational inefficiencies.

Retail Segment Growth Expected to Pickup

In the previous quarter, retail sales increased by 5% on a constant currency basis,  and 2% on a reported basis, driven by double-digit growth in international operations and e-commerce business, and global store expansion. North America retail operations were negatively affected by the negative impact of  currency fluctuations, even though comparable sales were roughly flat. Retail segment operating income was $194 million in the third quarter, $27 million or 12% lower than in the third quarter last year, and the retail operating margin was 16.9%, 260 basis points lower than the year before, reflecting the costs associated with the development of international stores and newly transitioned operations. In the fourth 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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1. Polo Ralph Lauren Investor Relations SEC Filings [↩]
2. Ralph Lauren Q3 FY15  Earnings Call Transcript, Seeking Alpha, February 2015 [↩]
3. Ralph Lauren’s Q4 2014 Results Earnings Call, Seeking Alpha, May 2014 [↩]