Polo Ralph Lauren: Doing Fine, But There's Cause for Concern

Polo Ralph Lauren (RL) is a well known designer and marketer of branded apparel and accessories. Some of its well known brands include Polo, Ralph Lauren Purple, Black, and Blue Label, Lauren, RLX, Chaps, and others. The strength of its branding has allowed the company to enter into licensor relationships, which allows producers of perfumes, colognes, sunglasses, jewelry, and home products to slap the Polo name on their merchandise in order to charge higher prices and increase sales volumes. Polo Ralph Lauren has three main revenue channels. The Wholesale channel (57% of 2008 sales) consists of sales to third party retailers, mainly higher end department stores such as Macy's (M) and Dillard's (DDS). Retail (39%) consists of sales through Polo's company-owned specialty stores, consisting of about 80 Ralph Lauren shops, over 160 Polo factory stores, 70 Club Monaco stores, a handful of Rugby shops, and over 100 international locations. Licensing revenues fill out the sales portfolio.

Polo Ralph Lauren is one of the few apparel brands that has stood the test of time. Founder and still CEO Ralph Lauren founded the company in the late 1960s, took it public in the late 1990s, and has delivered excellent 15% annual gains in operating earnings since then. Financial health and metrics have been strong. The company holds over $880 million in cash and short-term investments, versus total debt obligations of about $420 million. MFI return on capital has been steady and relatively strong at about 42% average since 2004 (nominal ROIC is equally good at about 15%). Free cash flow margin has steadily improved into the low teens. Polo is financially strong and efficiently run, covering the first investment pillar: financial viability.

What about another pillar, growth potential? The company has shown in the past that it knows how to grow, and there are still ample opportunities to expand. Perhaps the greatest potential is overseas, particularly in Europe and Asia, which Polo aims to derive 2/3rds of revenues from. Expanding the brand portfolio in several directions has been another strength. Polo has traditionally been considered a luxury brand for adults, but has also successfully developed mid-scale (American Living) and young adult (Rugby) brands that allow wider channel diversity and a larger customer base. This diversity allows Polo to capitalize on many markets at once, and also provides some protection from a fashion misstep in a particular brand. Growth potential still looks good, although perhaps not explosive.

The final pillar is also something I believe Polo Ralph Lauren can boast: durable competitive advantages, or moat. It's very difficult to have a moat in fashion... tastes are fickle and today's fad is tomorrow's Goodwill item. However, Polo has maintained the strength of its brands for over 20 years, and has proven that it knows how to build and maintain them. The company's long and steady history of profitable growth is a testament to the competitive advantages here. With such a wide and established set of brands, Polo can withstand a misstep or two, unlike many fashion companies that rely on single brands with ultimately short-term appeal. Their grip on retail store shelf space also protects sales. While consumer goods companies rarely have unassailable competitive positions, Polo's advantages here are about as much as you can ask for.

With the 3 pillars of investment covered, it would seem that Polo makes a good MFI pick, and indeed it just misses the cut for a MagicDiligence Top Buy recommendation. There are a few things that prevent me from recommending it. First is customer concentration and secular trends in retail merchandising. Macy's and Dillard's account for over 20% of sales. Weakness at either of these chains (particularly Macy's) would materially affect Polo's top line and profitability. Also, the department store channel is a dying one. In total apparel sales, department stores hold only about 16% of total market share, down from 20% in 2003 and quickly declining against discount mass merchants like Wal-Mart (WMT) and specialty stores like Gap (GPS). A continuation of this trend would hurt Polo, as increasing their company owned retail stores or pushing product into specialty retailers would be an expensive task.

The other concern is simply competition. MagicDiligence hates competition, as it is constantly a drain on revenues and profitability margins. Apparel is, simply put, cutthroat with thousands of competitors. Polo Ralph Lauren competes with a platitude of strong firms, including Jones Apparel (JNY), Liz Claiborne (LIZ), VF Corp (VF), and others too numerous to list here. While Polo's position appears to be strong, there are plenty of examples of seemingly strong apparel firms making a few missteps, crashing and burning in the process (remember Tommy Hilfiger?).

Polo Ralph Lauren is one of the most successful apparel branding companies out there, and at current stock prices makes a fine pick for your MFI portfolio. It just misses making the Top Buy recommendation list.

Disclosure: Steve owns no position in any stocks discussed in this article.

Comments

[Roger Knights:]

"Polo Ralph Lauren competes with a platitude of strong firms, ..."

Make that "multitude"

Mar 20 07:24 AM

[My Opinion:]

RL has made their image a little out of their league. They still cannot compete with Dior, D&G, Chanel etc. they try but will never be luxury like them. Their "image" of the homosexual male has made polo a poorly talked about subject in the community. They need to come off their "high horse" and back down to reality Ralph and know where you came from and maybe your stock will start to rise again.

Mar 30 05:47 PM

[Roger Knights:]

"Polo Ralph Lauren competes with a platitude of strong firms, ..."

That "platitude" was an amusing incongruous conflation of "plethora" and "multitude."

Apr 24 07:49 PM

[Steve Alexa...:]

Yes, thanks for the corrections guys. I need an editor!

Apr 27 04:32 PM