EUR 850.00 For Business Accounts Only

Morningstar | Ralph Lauren's Strategic Course Leads to International Gains, Despite Tepid U.S. Sales; Shares Rich

Narrow-moat Ralph Lauren reported better-than-expected first-quarter top-line growth of 3% (in excess of the 1% decline projected in our model) as the firm's turnaround strategy continues to take hold. The revenue growth was primarily driven by the international segments, with Europe and Asia leading the way at 8% and 19% growth, respectively. As management highlighted at the investor day in June, the firm continues to make progress on its strategic endeavors to improve the brand's standing by reducing promotional activity and increasing sales through direct to consumer, or DTC, and e-commerce channels. We surmise the fruits of these efforts helped drive a 120-basis-point improvement in gross margin to 64.4% and average unit retail increasing 8% for DTC. However, management reiterated its expectation for revenue to be slightly down to flat for the year (which is in line with our projections) due to reductions in off-priced shipments in the second half of the year and front-loaded wholesale shipments that benefited the first quarter at the expense of the second. As a result, we don't anticipate altering our full-year expectations or our $101 fair value estimate.

Ralph Lauren has continued to deliver operational efficiencies, posting a first-quarter-adjusted operating margin of 11.1% (up 90 basis points), even with a step up in advertising spend (up 20%) that demonstrates the firm’s commitment to supporting the brand intangible asset behind its competitive edge. This increased spend in addition to the pricing power highlighted in the gross margin improvement demonstrates why we believe the company has earned a narrow economic moat. We are encouraged that the firm has recommitted to investing in advertising (expects long term advertising to be 5% of sales versus 3.9% last year) as such expenditures should ensure the strength of the brand is unwavering in the increasingly competitive apparel industry, where switching costs are inherently low.

Wholesale distribution improvement also continues as the firm reduces underperforming stores (closed 13) and licensed partners (removed 17). As Ralph Lauren continues its SKU optimization and improvements in inventory management (inventory up 3.5% over the past year) this gives us confidence in our long-term assumption of approximately 12% operating margins. However, we believe the gross margin and cost efficiency improvements will be offset by increased advertising spend as the firm attempts to reaccelerate growth, thus limiting prospects for further profitability improvement.