Polo Ralph Lauren Corp. (NYSE: RL) designs, apparel, home, accessory and fragrance products under Polo by Ralph Lauren and other brand names in specialty stores, department stores, company owned stores, Club Monaco stores and outlet stores. RL's premium lifestyle brand continues to be the base of the company's success.
Sales for RL's third quarter rose 15% (which includes revenue from acquisitions). The retail segment rose 13%, driven by same store sales and new store openings. Wholesale sales rose 18% due to the acquisition and ongoing success of Chap's and Ralph Lauren brands. In addition to the strong sales growth, RL's operating margin increased by over 1% from the prior year to 16.1%. EPS rose 23% to $1.03.
Distribution is a key component of RL's success. RL expands near term growth prospects with the opening of new specialty stores, increased distribution at chains such as Kohl's (NYSE: KSS). Longer term RL has introduced a premium Purple Label line at Neiman Marcus and an edgier line at Club Monaco stores. Currently, RL is attempting to ease its dependence on the ever shrinking department store and expanding its specialty retail base.
Over the next five years, RL will attempt to open 70-85 specialty retail stores globally. Europe remains a large opportunity for growth. Asia has high potential as well. The company's wholesale unit (department store business) accounts for 51% of sales and about 46% of operating profit. The European segment of this business is key.
Currently at 15% of sales, the margins are double of its American operations. Polo also sells more luxury goods and high end goods in Europe. RL is also nursing a new franchise, Rugby, which was expected to grow to 50 units in 3 years. The plan has now accelerated to 50 units/year.
The strategy is paying off. RL's growth requires minimal capital. Pre-tax return on capital is approximately 30%. Free cash flow is strong and RL's return on assets is 11.9% and ROE is 18.2%. Debt to total capital is low at 14.6%.
RL has also been aggressive at increasing its margins. RL has been increasing its overseas manufacturing capacity. Now the vast majority is from overseas (compared to nearly zero, 10 years ago). Additionally, RL has consolidated many of their IT systems and has developed new sourcing methods that eliminates some of the higher costs of holding inventory.
The retail business is highly competitive. Fashion trend missteps are a disaster and styles are easily copied. RL is somewhat insulated as they have historically stuck with classic styles. One additional positive for RL is that by becoming a hybrid retailer (department store and specialty stores), they can have the polo brand reaching consumers. The apparel industry is estimated to be over $160 billion and RL's products fill about 30% of the market. Discounting remains one of the biggest risks to Polo's markets. The department stores are also moving more toward private label brands and Polo's major exposure is approximately 20% of its revenue comes from Federated and May (NYSE: FD) department stores. The specialty store expansion and overseas growth is expected to mitigate the risk.
A larger concern for investors is Mr. Ralph Lauren's stock ownership. Mr. Lauren owns nearly 45% of the outstanding shares but accounts for over 88% of the shareholder votes. This effectively gives him control of seven out of nine board seats. As scrutiny over corporate governance increases, the current ownership structure of RL makes it unattractive for investors.
On a valuation basis RL is close to fair value as it is trading at 21 times next years fiscal earnings. Based on the assumption of double digit growth and earnings growth, RL is selling in line with the industry PEG ratio. It can be argued given the high quality of the brand and the consistency of RL that RL should sell at a premium to its peers. Improving margins may provide a positive surprise to RL's earnings announcements. Strength in Europe and Asia will push sales, margins and earnings higher over the next 3 to 5 years. As is typical of most retailers there is not a high dividend payout so investors to do receive a substantial return while waiting. However, RL is currently trading at an all-time high. Investors, with that in mind, would be advised to wait for a pullback before acquiring a position in the stock.
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