Has Ralph Lauren Seen the Best Days?

Joining the parade of negative top line growths from the high-end retailers, PVH, and Michael Kors, Ralph Lauren (NYSE: RL) missed its revenue by -4.14% for Q3 2016, but met with a disproportional stock market response of more than -22%.  RL’s top line shortfall can be easily attributable to the factors such as unfavorable currency headwinds, slower tourism, lower consumer sentiments which affect practically all apparel retailers negatively.

Even the weather does not cooperate.  An unusually warm December followed by a “wet/cold’ spring in progress built up inventory in the channel. The 2016 top line growth is under pressure.   The resulting aggressive promotional activities also put the bottom line at risk with a 200-250 bps drop in operating margins.

Furthermore, no retailers can ignore the elephant in the room.  For 2015, while RL’s retail same (brick and mortar) store sales decreased by 7% sequentially, its ecommerce sales grew 14%.  Over the same time period, RL’s total revenue increased $170 million with $110 million from ecommerce.  The high online growth may be impressive but misleading, since it is the non-company ecommerce, such as Amazon and EBay, has taken out RL’s wholesale customers.  The Macy’s and alike virtually have had no growth in recent years.

Consequently, RL experienced more than -6% drops in their wholesale segment.  As over 40% of total wholesale revenues is generated by 4 major customers, Macy’s, Kohl’s, Hudson’s Bay, and TJX, Macy’s recently announced closing 36 of their 770 stores, which have produced close to 20% of RL’s revenue, didn’t sit well with RL’s shareholders.

The next shoe to drop is that if their second largest customer, Kohl’s, with a 10% revenue exposure, may follow suit.  The damage from ecommerce filters through to the bottom line. The shift from company store sales to outside online sales also crushed RL’s margins nearly in half from 18% to 9.70% for the last 3 years.

So, after all the bad news has been out and expected to worsen in the short run, we are looking for issues unique to RL that they will have to face in the long run.  For one, as “fast fashion” is a living thing, the 76-year old Ralph Lauren has been criticized for not keeping up with the next generations’ trendy styles.  The word “Polo” has been turned into an eponym since 1972.  After all, I am still wearing exactly the same Ralph Lauren Polo style as 40 years ago.

On the other hand, Ralph Lauren is Ralph Lauren. They do not compete with Bergdorf or Brooks Brothers.  They are no Abercrombie & Fitch or Old Navy, but they do compete with Michael Kors and Calvin Klein.  In May 2014, RL’s 14-year partner, Roger Farah, left for a major competitor, Tory Burch.  We were a little concerned then, because Farah has been a great COO as Lauren has been a talented designer.  We don’t know whether this was the reason that both RL stock and revenue have not been able to come out of 2014’s low.  It is, therefore, not surprising that when Ralph Lauren, the 83% shareholder, announced to step down from the CEO, it was met with a +12% increase in stock prices.

Apparently, the RL shareholders like the successor, Stefan Larsson, who is exactly what RL desperately needs.  Previously, he had added $1 billion revenue to Old Navy by creating trendy clothing lines at affordable prices.  In the international front, Asia remains the only area that people still think wearing an expensive polo shirt with a little horse on it is a status symbol.  Yet, with an over 30% of international sales, Asia especially China is under penetrated by RL.  We like Larsson’s international branding and retail experience as he has brought H&M, a global retail branding giant, from $3 billion to $17 billion in annual revenue, and from 12 to 44 countries.

Per our valuation, RL’ stock has more than priced in all the bad news out there.  Forward looking, irrespective the short-term economic headwinds, and considering Larsson’s only 3 months in office, we believe RL’s investment thesis is still intact.  RL is down but not out.

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