Ralph Lauren Q1 2016 Earnings Review: Results Meet Expectations In Spite Of Currency Headwinds

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Ralph Lauren

Premium lifestyle brand, Ralph Lauren (NYSE:RL), experienced another promising quarter, with revenues meeting expectations and profits exceeding expectations. The company reported $1.6 billion in revenues, which was 5% lower than that reported a year ago predominantly against currency headwinds. Although the brand’s performance in the U.S. did not shine as it did in Q4 2015, its international markets reported double digit growth. Furthermore, unlike the last quarter where internet and wholesale routes were drivers of sales, this quarter benefited from growth in retail and licensing avenues. While a 5% decline in revenues may not seem very reinforcing, we believe that Ralph Lauren could be poised to achieve much going forward for a number of reasons. Here are the key takeaways from Ralph Lauren’s Q1 earnings and why we remain optimistic on future prospects for the company.

Trefis has a $141 price estimate for Ralph Lauren, which is above the current market price. We will be updating our model in light of the earnings release.

A Snapshot of Major Trends and Future Prospects

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U.S. performance may be weaker in the fiscal year: In Q4 FY 2015, the U.S. was the star performer with revenues growing 8% on a currency-neutral basis. However, this did not work in Q1, where a strong dollar choked off customer traffic resulting in double digit growth in Asian and European markets where traffic surged. Ralph Lauren in European and Asian countries, where revenues increased 10% and 9% respectively, benefited in the quarter from an increase in tourist population, who looked to take advantage of weaker currencies. Now, will this trend follow through in the rest of the year? Probably. According to Trading Economics forecasts, while the dollar strength (measured by the U.S. Dollar Index) is expected to ease in the next quarter to about 96, from about 98 presently, the currency is expected to appreciate further to trade at about 100 over the next 12 months. In this situation, this trend where customer traffic moves from the U.S. to international markets could continue for the rest of the year.

Luxury segment could drive revenues: In Q4 2015, Ralph Lauren indicated a merger of the company’s many luxury brands to create one label for women and one for men, to simplifying and to better drive the brand’s luxury status. This strategy was received in good light in its rudimentary phase and will be implemented in its totality in the brand’s Spring collection. While the company has worked to elevate and simplify their luxury status, they have also tried to drive the luxury notion in the accessories realm with the Ricky handbag line. The company has indicated that they will continue to extend their luxury portfolio, particularly in bags and accessories. In this case, Q2 and the full fiscal year results could benefit from the company’s luxury offerings.

Innovations could be the key to growth: Ralph Lauren has been working on new launches, which could guarantee better performance in the full year. In Q1, the company introduced a new Polo Sport line, an extension of the company’s trademark Polo brand in active wear. The management indicated that the brand has been well received by customers, as evidenced by pre-orders on the company’s website. Later this month, this line will be launched in stores, which could go on to exert a positive influence on revenues in the next quarter and full-year. The company has also extended its Polo brand for women and will be expanding the line in the second half of the year. Apart from apparel, Ralph Lauren also saw strong performance in its denim, footwear, accessories, and home categories. To sum up, a strong product portfolio, coupled with new launches in line with the current fashion trends, could go on to aid sales for Ralph Lauren in Q2 and in the full year.

An Update On Structural Changes 

In Ralph Lauren’s previous earnings call, the company spoke of major changes in the management structure, which would entail breaking down the business on the basis of six key brands. Each of these subdivisions are expected to be headed by a unique leadership team, who, with the help of brand specific expertise, will see the division through integral functions such as designing and merchandising. The management in its Q1 earnings call gave updates on this front. In the Fall of fiscal 2016, the new management structure will be implemented with the Polo brand to assess performance before being extended to other brands. The management hopes that the new structure will result in “significant reduction in SKUs as well as sample and design costs, which will lead to better inventory turns, higher gross margins, and meaningful SG&A cost savings.”  However, the continued implementation of this program is expected to weigh on margins in the fiscal year, by increasing costs by $70-$100 million. The company also opened 6 directly operated, and 15 license stores, in Q1, and are well on their way to open 40-50 stores in the full year. An extended footprint across the world could also help Ralph Lauren garner higher shares in the luxury lifestyle space.

A Note On Currency

As mentioned earlier, currency headwinds in the form of a strengthening dollar, continued to weigh in on financial results, apart from disrupting demand in North America.  While a strong dollar has strayed tourists and consumer traffic towards markets with weaker currencies, to pull down demand in the U.S., a weaker domestic currency has translated into fewer dollars to adversely impact the company’s income statement. In order to deal with currency related drags, the company has resorted to price increases in a number of markets that have experienced currency depreciations. Since most other brands in the luxury lifestyle space have also resorted to these strategies to avoid adverse impacts on financials, Ralph Lauren may not lose out on the basis of price competitiveness.

In conclusion, we believe that Ralph Lauren has displayed solid performance in the quarter on a currency-neutral basis. A strong product portfolio, coupled with promising company specific strategies, could see Ralph Lauren touching greater heights going forward. While we expect currency headwinds to remain a drag on results even in the ensuing quarters, it may not be accurate to judge a company’s performance on this basis. If the U.S. dollar eases over time from its current robust levels, Ralph Lauren could see even stronger performance.

Key Financial Results – Q1 2016

  • Net revenues were recorded at $1.6 billion, declining 5% year-on-year on a reported basis.
  • Fall in net revenues accounts for a 500 basis point negative impact of currency headwinds.
  • Wholesale segment sales declined 6%, retail sales increased 3%, and licensing revenues increased 6%, year-on-year on a currency neutral basis.
  • Gross profit was recorded at $969 million, with a 59.8% profit margin.
  • Net income stood at $95 million, or $1.09 per diluted share.

Q2 FY 2016 Guidance

  • 3-5% increase in revenue on a constant currency basis
  • Currency headwinds expected to have 550 basis point negative impact on revenue growth.
  • Operating margins expected to be 275-325 basis points lower year-on-year because of currency headwinds.

Sources:

  1. Ralph Lauren Q1 2016 Results – Earnings Call Transcript
  2. Ralph Lauren Q4 2015 Results – Earnings Call Transcript
  3. Form 10-Q, SEC
  4. Form 10-K, SEC
  5. First Quarter 2016 Income Statement Review

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