Ralph Lauren: There Is Light At The End Of The Tunnel

Not too long ago, premium lifestyle brand Ralph Lauren (NYSE:RL) was seeing bright days, with the stock trading at over $180. However, over the past year, the company’s stock has come tumbling down to prices as low as $105 last month, as a strong U.S. dollar and the slowdown in China weighed on prospects. While these headwinds do not seem to show any signs of reversal in the short to medium term, we believe there is light at the end of the tunnel for Ralph Lauren. Here are the top factors why Ralph Lauren may be headed in the right direction, along with a discussion of present headwinds and the repercussions going forward.

Source: NASDAQ

What could work?

Let’s start by discussing the steps Ralph Lauren has taken recently to grow the company. Having to work in a tough environment pushes every business house to maximize efficiency and that is exactly what Ralph Lauren seems to be on its way to doing.

In 2016, Ralph Lauren will see massive restructuring on its management side. This includes breaking down the brands into six parts or sub-brands. Each of these sub-brands will have its own leadership, and a team that will be in charge of all integral functions related to the brand. This is a move toward specialization, where there will be one team that will try to understand everything related to one brand right from designing and manufacturing, to marketing and brand perception. Clearly, this higher degree of specialization will allow the relevant team to have a better understanding when it comes to the dynamics at play with regard to that brand, and thereby allow them to come up with effective counter strategies to see the brand through.

Apart from simplifying things on the management front, Ralph Lauren is also resorting to brand restructuring. In this regard, the company will be seen merging its luxury brands, to create one label for men and one for women. This is expected to both simplify, and hone, the luxury message surrounding the brand. Apart from this, Ralph Lauren has also taken steps to extend its premium status by including new brands, such as the Ricky handbags line, to its accessories portfolio. Furthermore, the company is also leveraging its already established brands such as Polo to delve into new spheres. This includes the introduction of the Polo Sports line, an extension of the company’s trademark Polo brand in active wear.

Last, but not the least, after almost 50 years, Ralph Lauren has stepped down as CEO and has handed control of his company to Stefan Larsson. Larsson could definitely guide Ralph Lauren to new heights, just as he had done previously with H&M and Old Navy. Under his leadership, Old Navy last year posted an 8% increase in year-on-year sales, to constitute Gap’s biggest business. Prior to that, Larsson was instrumental in seeing H&M through during its phase of global expansion. Given his years of experience in this line of business, Larsson will have much to contribute to Ralph Lauren, as well.

How long will headwinds persist?

Now, moving on to what is slowing Ralph Lauren down. This could predominantly be attributed to a strong U.S. dollar and a slowdown in China.

Let’s start by looking at the strengthening dollar. Over the past year, the U.S. dollar has continued to strengthen – from about 80 points, the U.S. dollar index reached around 100 in 2015. The biggest reason for this development has been the Quantitative Easing (QE) taper, which has led to investors increasingly directing funds to the dollar in anticipation of an interest rate hike. Last month, the Federal Reserve once again resisted a rate hike stating lower global growth and low domestic inflation as prominent reasons for the step. However, even when the Fed does ultimately raise rates, the dollar strength may only be exacerbated as billions of dollars chasing risky investment opportunities in a number of emerging markets continue to spill into the dollar. Now, Ralph Lauren loses out when the dollar strengthens primarily because it moves tourists away to countries where currencies have weakened, which brings down demand in regions such as North America. Furthermore, as the domestic currency weakens, less is recovered when these are converted into the dollar and thereby exert an adverse impact on the company’s financials. Clearly, from the arguments above, it seems unlikely that the dollar index will slip back to the 80s or below any time soon. Hence, in the short to medium term, Ralph Lauren’s best case scenario is that the dollar remains stable at the current levels.

U.S. Dollar Index (DXY), Market Watch

Next, let’s look at what is happening in China. China is an important market for Ralph Lauren for many reasons. While the Chinese middle class grew as the economy underwent phenomenal double-digit growth over past three decades, the aspiration for luxury products resonated with the Chinese. Furthermore, these consumers are also important in driving luxury spending in other markets, such as the U.S. and Europe. Based on the Chinese phenomenon, Ralph Lauren anticipated its Asia division to account for about a third of sales, from about 12% currently. However, luxury spending in China took a hit, first with the “anti-extravagance” drive, and then with growth rates slowing down to record-lows. However, China’s story might turn out to be different, in the sense that Ralph Lauren may not have to write off the lucrativeness of the region, just yet. For one, China’s high growth days were bound to become unsustainable at some point and this might indicate a move to the “new normal” that is more sustainable in the long term. Secondly, even at a projected 7% rate, the Chinese economy is growing manifold in absolute terms, which could mean higher purchasing power and higher luxury spending going forward. Thirdly, both the anti-extravagance and slow growth can be attributed to the policy stance in China. Given that policy stances can change over time, the situation in China could turn around to improve profitability for names like Ralph Lauren. Lastly, while much is spoken of the slowdown in China’s manufacturing activity, little is spoken of the consumer sector, which witnessed double-digit growth in August. Hence, the Chinese economy could be in a transition phase, and is, in fact, moving to a norm that could be more sustainable. Given this, it may not be entirely accurate to underestimate the prospects that this market holds for Ralph Lauren in the long term.

In conclusion, we believe that there are a number of factors that could pan out in Ralph Lauren’s favor going forward. However, we expect headwinds to continue to put pressure on the results, at least in the short to medium run. However, we believe that Ralph Lauren has everything in place at a fundamental level that could guarantee growth in the long term.

Trefis has a $141 price estimate for Ralph Lauren, which is above the current market price.

Sources:

1. Ralph Lauren Q1 2016 Results – Earnings Call Transcript
2. Ralph Lauren Q4 2015 Results – Earnings Call Transcript
3. Form 10-K, SEC
4. Ralph Lauren steps down as CEO, with Old Navy president to succeed him
5. Federal Reserve puts rate rise on hold – as it happened

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