Ralph Lauren Q2 2016 Earnings Preview: Efficiency Could Steer Performance While Currency Headwinds Persist

Premium lifestyle brand Ralph Lauren (NYSE:RL) is set to post fiscal second quarter earnings on November 5. The company’s results in Q1 continued to be plagued by currency related headwinds, although revenues met analyst expectations and profits beat expectations. The company’s solid currency neutral results were guided by double-digit revenue growth in international markets, even as performance in the U.S. remained somewhat of a drag. Let’s discuss below what might be in store for Ralph Lauren going into Q2.

Strong Brand Portfolio Could Continue To Win

Although Ralph Lauren has been struggling in recent months because of currency related issues, the company’s business fundamentals continue to remain strong. Furthermore, it has resorted to other means of driving efficiency in its brands. This includes merging its many luxury brands to create a single label for men and one for women. This is expected to simplify the luxury status surrounding these brands. This strategy has been well-received in its elementary phases, and Q2 could benefit from the strategy being applied in its entirety. Ralph Lauren has also been working to improve its current product portfolio, particularly of signature brands. This includes expansions in the Ricky handbag line in accessories and the Polo brand in apparel.

In June, Ralph Lauren unveiled the new Polo sport brand, which showed great promise primarily based on pre-orders. Over the last few months, the company extended the brand to other stores both in the U.S. and internationally. Hence, the expansion of this new line could help Ralph Lauren garner revenues in the quarter. Apart from the sports line, Ralph Lauren will also be widening its offerings in the women’s category for the Polo brand, which could also give the brand further traction. In addition, Ralph Lauren is looking to expand its footprint, in that the company has opened 6 directly operated and 15 license stores in Q1, and is well on its way to opening 40-50 stores in the full year. This could garner Ralph Lauren a higher share in the premium lifestyle market.

North America versus International Performance 

While we expect Ralph Lauren’s strong brand portfolio to be the main driving factor in Q2, it is worthwhile to explore some other noticeable trends in Q1. For one, Q1 saw sluggish sales in North America, while international stores posted double-digit growth. This was predominantly a result of the strong dollar, directing tourists to countries in Europe and Asia where currency strength was relatively weaker. Hence, Europe and Asia posted growth at about 10% and 9%, respectively, in Q1. Now, could this trend continue going into Q2? Possibly. For one, the dollar has showed little signs of easing, as the currency strength, measured by the U.S. Dollar Index, has fluctuated between 93 to 98 points over the past four months. Furthermore, given the extent to which the U.S. dollar has strengthened in recent quarters, it might have to undergo a dramatic decline in order to attract tourists back to the country. Given this, we anticipate relative weakness in revenue growth for the North America division even in this quarter, while international stores could continue displaying strength.

Looking Beyond Q2 – Some Costs But More Benefits

Ralph Lauren’s core strength lies in the simple fact that the company has been striving to garner efficiency in the face of a difficult macroeconomic backdrop. While we have already discussed the steps it is taking to improve its product portfolio and brands, it has also indicated major structural changes on the management side of things. This includes breaking down the company into six key brands. The new structure could hone efficiency, as each of these brands will have its own leadership, and a team that will be in charge of all integral functions such as designing and merchandising related to the brand.

In the fall of 2016, this new structure will be initially applied to the Polo brand before extending to others. While the continued implementation of this program could prove to be a drag on the results this fiscal year, with costs increasing by $70-$100 million, it could 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.”

Last, but not the least, are currency related headwinds. The 5% decline in revenues posted in Q1 can primarily be attributed to the strengthening dollar. While on one hand, a strong dollar had strayed tourists away from the U.S. and dragged down the North America divisional revenues, it has also reduced revenues from international markets when converted into dollar terms. In order to mitigate the impact of the latter, Ralph Lauren resorted to price increases in a number of key international markets. However, since many other luxury brands have also resorted to the same strategy, we do not anticipate Ralph Lauren to lose on grounds of a lack of competitiveness. Given that the U.S. dollar has shown little signs of easing over the past few months, more so as the Federal Reserve resisted the much awaited interest rate hike, we anticipate currency headwinds to continue being a drag on financials even in Q2.

In conclusion, Ralph Lauren is wading through tough macroeconomic conditions, which has exerted an adverse impact on demand as well as general finances. However, the company’s strong brand portfolio, coupled with steps to move towards a more efficient way of functioning, supports growth, going forward.

Trefis has a $134 price estimate for Ralph Lauren, which is above the current market price. We will be updating our model in light of the earnings release.

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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