Ralph Lauren: A Critical Look At Its Business Fundamentals

| About: Ralph Lauren (RL)
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Despite its massive underperformance in last few years relative to the market, the stock of Ralph Lauren is still risky to add in the stock portfolio.

The company announced departure of the company CEO, Stephan Larsson, on Thursday due to the disagreements with the founder Ralph Lauren.

The company reported earnings per diluted share (EPS) of $0.98 for the third quarter fiscal 2017 as compared to $1.54 in the same period last year.

The key fundamental analyses indicate that the company is in deep trouble; therefore, the investors should be very careful before putting their eggs in Ralph Lauren’s basket.

Investment Thesis

Despite its massive underperformance in last few years relative to the market, the stock of Ralph Lauren Corporation (NYSE:RL) is still risky to add in the stock portfolio. The fundamentals of the company are poor as compared to its industry peers, and there are no sufficient signs of improvement in them yet. The capital providers should be very careful before investing in the company. Ralph Lauren would take the time to show satisfactory progress.

Source: Yahoo Finance

Ralph Lauren has been a consistent underperformer relative to the broader market since many years back. The stock has declined more than 12% in the last one year as compared to the market's appreciation of 22% in the same period. Over the longer term, it has massively underperformed the market due to its sub-par business performance in relation to the industry competitors. The founder of the company Ralph Lauren has utilized different tactics in order to compete in the challenging business environment.

To continue its plan to make the struggling lifestyle brand a competitive business, Ralph Lauren appointed Stephan Larsson as the company's chief executive officer (CEO) in November 2015. Larsson was a superstar CEO of his last company, Gap Inc. (NYSE:GPS). After joining Ralph Lauren, he took the company on a serious note and introduced a turnaround plan (Way Forward) to achieve $180-220 million in annualized savings. Larsson immediately took action on the plan by closing stores, firing employees, and bringing the brand to the modern values. However, he was in the midst of the plan when the news of his departure came. The company announced on Thursday, February 02, 2017, along with Q3 fiscal 2017 earnings call transcript, that the CEO will leave the company on May 1 due to the disagreements between him and the founder Ralph Lauren about creative and consumer-facing parts of the company's business. This sudden news has created a new debate about the company's turnaround plan and its future business prospects. The stock dropped more than 12% on Thursday after Larsson's departure news. Neil Saunders, managing director of GlobalData Retail, commented on the departure news as:

"This sudden departure gives the impression of a brand in crisis, and we believe it signals significant internal wrangling over the future direction of the firm. As much as Ralph Lauren should be respected for his significant achievements and his undeniable design talent, we are concerned by the orthodoxy of his leadership, under which questioning and fresh thinking are relatively rare."

The news of the Larsson's departure is not the only factor that pushed the stock under pressure. Ralph Lauren reported third quarter results for fiscal 2017 on Thursday. The results are not encouraging as well. According to the release, the net revenues declined to $1.7 billion, a 12% drop from the same period last year. The company reported earnings per diluted share (EPS) of $0.98 as compared to $1.54 in the same period last year. The Wholesale segment was the culprit behind this unfavorable business performance, which reported 26% drop in revenues from the corresponding period of the previous year. This represents a concentration problem as Macy's (NYSE:M) account for almost 25% of the company's Wholesale business and the retailer is also in deep difficulties.

The following graph shows quarterly results of last three years. It is obvious that the business of Ralph Lauren is not generating any wealth for its shareholders. On the forward-looking basis, the company is maintaining its guidance for fiscal 2017.

Source: Bloomberg

Deutsche Bank analysts also raised their concerns about Ralph Lauren's future business prospects. According to the bank:

"Ordinarily, Ralph's fiscal third-quarter results would have been heralded in today's lackluster retail reporting season, but CEO Larsson's decision to depart overshadowed that news. While management was vague about the specific nature of these disagreements, we believe they could pertain to product design and customer positioning, both critical to the next phase of the turnaround."

Key Business Fundamentals

Let's have a look at Ralph Lauren's business fundamentals. To dig deeper about company's business prospects, I picked a few key fundamentals relating to profitability, asset utilization and efficiency, and financial position. It is not strange to know that almost all of the company's fundamentals are in trouble in relation to its peers and are significantly lower than peers' average fundamental measures. Ralph Lauren's profitability measures are much lower than peers' average measures. Its operating margin is just 4.21% as compared to 12.88% average operating margin for industry peers. Similarly, net margin is way behind the peers' average net margin measure.

Source: Author's Calculations/Stockrow.com

The following graph shows the historical trend in some of Ralph Lauren's business fundamentals. This trend also indicates that the company's business prospects are fading.

Source: Morningstar

Now, look at the management's efficiency in terms of asset utilization and wealth generation. First, the return on assets (ROA) of the company is only 3.15% as compared to 12.92% average measure for its competitors, meaning the company is not utilizing shareholders' assets efficiently. Secondly, return on equity (ROE) and the return on invested capital (ROIC), the two most relevant return measures for capital providers, are really at disappointing levels. Both return measures indicate that Ralph Lauren is not adding sufficient wealth to capital provided by its investors as these return measures are substantially lower than the average return measures of competitors. Thirdly, Ralph Lauren's cash conversion cycle (CCC) has crossed 150, which is much above its historical average. This converts to inventory turnover under 3 times that is also less than its historical average of above 3. This indicates that the company's efficiency in inventory management is getting weaker.

Source: Morningstar

Additionally, the historical trend in return on invested capital is downward sloping, which means the company's ability to generate wealth for investors' capital is sharply deteriorating, which is a red signal for the capital providers. Moreover, Ralph Lauren's leverage position is getting worse as shown by the below graph. These key fundamental analyses indicate that the company is in deep trouble; therefore, the investors should be very careful before putting their eggs in Ralph Lauren's basket.

Source: Stockrow.com

Ralph Lauren's valuation indicates that the stock is undervalued as its EV/EBITDA multiple is 6.94x as compared to industry's multiple of 9.93x, and its forward P/E multiple is 14.51x as compared to the industry's multiple of 18.30x. However, the business fundamentals don't support the buy call; therefore, dictate a "hold" stance for the stock. The investors are advised to best wait until the company shows sufficient omen for the business improvement. The UBS analysts cut their price target on the stock to $76 from $107 based on the recent developments. According to the UBS analysts:

"The incremental revenue obscurity from deterioration in U.S. end-markets recently, plus the sudden CEO departure… significantly increases the risk to our top-line forecasts, and offsets much of the EPS opportunity from improving margins that were [the] underpinnings of our buy rating."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.