EUR 850.00 For Business Accounts Only

Morningstar | Ralph Lauren Posts Strong 3Q as Strategic Initiatives Continue to Unfold; Shares Aren’t a Bargain

Ralph Lauren's brand intangible advantage, the source of its narrow moat, was displayed during the third quarter by healthy sales growth, supported by marketing and digital initiatives. Sales grew 5% (versus our full-year forecast of up 1%), led by a 9% improvement in average unit retail, or AUR, stemming from improved digital sales (up 20%), reduction in off-price/promotional activity, and fresh product assortments. Management again raised full-year sales expectations to slightly up (versus flat to slightly up) and operating margins targets to up 60 basis points (from a prior range of 40 to 60 basis points). However, this tracks our full-year expectations of 1% sales growth and operating margins improving 90 basis points (to 11.5%). As a result (and despite the high-single-digit share price increase on the release), we do not intend to alter our $107 fair value estimate and would suggest investors await a more attractive entry point.

Impressively, the firm improved operating margin, by 70 basis points to 13.9%, while increasing advertising spending by 18% (on top of a 27% increase last year), which we believe successfully translated into higher AUR sales and brand engagement targeting consumers in underpenetrated demographics like Generation Z and millennials. Adding credence to this belief, management cited that one third of the consumers who shopped products highlighted in its holiday campaign were new, with a meaningful portion under the age of 35. While we view these brand investments favorably (the firm plans to increase spending toward its long-term target of 5% of sales, up from 4% in the quarter), we remain skeptical of the sustainability of long-term AUR growth, as any error in pricing or overexpansion could lead to discounting issues that plagued the firm’s profitability in 2016 and 2017.

As such, we aren’t wavering on our forecast calling for sales growth of 1%, gross margins of 62%, and operating margins of 12% on average over the next 10 years. And despite its recent improvement, we maintain that Ralph Lauren must tread carefully as it fine-tunes its sales tactics, balancing top-line growth with brand-accretive strategies in a highly competitive retail environment, given switching costs are negligible and fashion trends shift constantly.