Ralph Lauren: Strong Brand, Weak Trend

Summary

• Ralph Lauren has drivers to take a closer look at (rumors of a deal with Kering, brand strength and course for transformation).
• The personal luxury goods market will continue to grow in the coming years.
• The company's financial performance has been declining in recent years and is likely to continue to decline.
• Insiders have been actively selling in recent years.
• The company is trading at a fair price, I do not recommend buying.

Photo by NoDerog/iStock Unreleased via Getty Images

Investment Thesis

"What we're trying to find is a business that, for one reason or another - it can be because it's the low-cost producer in some area, it can be because it has a natural franchise because of surface capabilities, it could be because of its position in the consumers' mind, it can be because of a technological advantage, or any kind of reason at all, that it has this moat around it. – Warren Buffett

One of the main types of competitive moats is the strength of a company's brand. It's hard to find an industry in which companies have the same brand power as the luxury goods industry.

Ralph Lauren (NYSE:RL) is one of the world leaders in the production and distribution of luxury goods in terms of sales. Over the past year, the company's stocks are up 80%. RL has a number of potential growth drivers, including a possible takeover by the luxury giant and a course of transformation. However, I do not recommend buying, as the company has been demonstrating negative financial dynamics in recent years, and its valuation is close to a fair level. My recommendation is to hold.

Company Profile

Genius, billionaire, philanthropist, fashion designer. You can give Ralph Lauren a lot for his costumes - tens of thousands of dollars, the Order of the Knight of the British Empire in 2019, the keys to New York City in 2010 and your own soul. The clothes of this fashion house are chosen by the most significant figures from Princess Charlene to David Beckham and Melania Trump.

Ralph Lauren was founded by Ralph Lauren in 1967. Now it is one of the world leaders in the production and distribution of luxury goods in terms of sales. According to Deloitte, the company is ranked 13th in the “Global Powers of Luxury Goods top 100” and occupies 14% of the premium segment for clothing and footwear.

(Source: Deloitte)

RL operates in the following categories: Apparel, Footwear, Accessories, Home Furnishings, Fragrances and Hospitality. The company consists of the following brands: Ralph Lauren, Ralph Lauren Collection, Ralph Lauren Purple Label, Polo Ralph Lauren, Double RL, Lauren Ralph Lauren, Polo Ralph Lauren Children, Chaps, and Club Monaco. In its annual report, the company identifies three key territories: North America, Europe, Asia; and three distribution channels: retail stores, concession agreements and online platforms. North America accounts for 51% of net revenue, Europe 26% and Asia 17%.

Currently, the main executives are:

• Ralph Lauren (Chairman/Chief Creative Officer/Founder);
• David Lauren (Vice Chairman, Chief Innovation Officer/Chief Branding Officer);
• Patrice Louvet (President/CEO);
• Jane Hamilton Nielsen (Chief Operating & Financial Officer. Executive VP).

The shareholder structure is presented below:

(Source: Marketscreener)

As of March 28, 2020, Ralph Lauren himself or entities controlled by the Lauren family own about 84% of the votes in the company's ordinary shares.

Industry Overview

Ralph Lauren operates in the personal luxury goods market. According to Bain & Company, by the end of 2020, the market volume decreased by 23%, from 281 to 217 billion euros. It was the first drop since 2009 after permanent growth.

(Source: Statista)

The worst hit categories were apparel (-29.2%) and hard luxury (-25.8%). In general, the following trends are observed in the market:

• Due to the pandemic, fashion houses have lost good revenue from the sale of resort collections. The share of local purchases reached 80-85% this year;
• China became the only region that showed growth in the luxury market by the end of 2020 (+45% to 45 billion euros). Market size in Europe and America has significantly decreased (-36% and -27%, respectively).
• 40% to 50% of luxury goods purchases were made using digital technologies;
• A focus on recycling and smart consumption. The market for used luxury goods is valued at 28 billion euros;
• The trend of minimalistic luxury. It is believed that logomania and hard luxury were the material equivalent of the early 2000s, when a $ 2,000 bag defined personality status. The counterfeit market is now more extensive than ever. The modern consumer is increasingly looking for inclusiveness, companies are introducing customization, creating capsule collections and collaborations.

Bain analysts expect a CAGR of + 10% to 19%, depending on the development of COVID-19 and the resumption of international traffic. They also expect the market to recover by 2022 and continue to grow at 10% between 2020 and 2025.

Bullish Factor 1: Market Consolidation

There is an active consolidation in the market. We see active M&A deals of such industry giants as LVMH (OTCPK:LVMHF), Kering (OTCPK:PPRUF), Richemont (OTCPK:CFRHF). In mid-2020, the world's largest luxury deal closed - LVMH acquired Tiffany & Co. for $16.7 billion. It is likely that LVMH's competitors will try to balance the forces. However, there are not many acquisition opportunities left in the market. Family-owned companies such as Chopard, Chanel, Prada remain good but unlikely opportunities. Potentially, publicly traded companies that do not have a controlling shareholder appear to be good acquisition targets. The most famous of these are Burberry (OTCPK:BURBY) and Ralph Lauren (RL).

There are active rumors about Kering's desire to acquire Ralph Lauren. According to Betaville Intelligence, the board wants a minimum of $150 per share. In my opinion, such an estimate looks fair (see the Valuation section), but does not represent a significant upside to the current price. However, the volume of insider sales suggests that the company's management (apparently) does not expect anything like this in the near future.

(Source: Marketbeat.com)

Bullish Factor 2: Brand Strength and Transformation Course

On March 26, 2021, RL presented a new collection. The show "All or nothing" took place in the foreground with a video presentation. It can be called an immersion fashion experience with catwalk and vocal accompaniment. The men's and women's collections were presented at the same time - another feature. The Ralph Lauren SS 21 collection has received rave reviews from Fashionista, VOGUE and L'OFFICIEL. VOGUE described the collection as follows:

Ralph Lauren is a safe haven – a steadfast source of contentment when you most need it – and an everlasting wardrobe that feels even more desirable in a time of turmoil and resets.

However, investors are primarily interested not in the responses of fashion magazines to the freshly baked collection, but in the sales volumes of this collection. RL's sales depend little on short-term fashion trends, as the company uses a certain pool of styles, colors, ornaments and textures that flow from one collection to another. It is both the power and the curse of Ralph Lauren. Strength because sales are relatively easy to predict. Curse because sales have been steadily declining since 2017, and success at a fashion show doesn't necessarily change the trend. However, the trend can be corrected by a transformation course. The company recently announced a program to launch a subscription apparel rental for $125 per month. A stylist, free shipping, return and dry cleaning feature is available, and used clothing will be donated to the Delivering Good charity. This is a move by the company towards a young audience focused on ethics, sustainability and sharing economics.

Why We Are Neutral. Financial Performance

I always prefer to start with ROE in my analysis of financial performance. In my opinion, this is the main indicator, because it determines the profitability that the share of assets owned by shareholders generates. ROE can mislead you as it can be easily manipulated by increasing financial leverage. Therefore, it is important to consider ROE in the context of its three components: net profit margin, asset turnover and leverage.

(Source: Created by the author)

From 2011 to 2017, the net profit margin remained stable. The company was actively increasing sales, keeping the share of costs in revenue at a stable level. Management has always been effective in cost controlling. Margin dropped significantly in 2017. Here we are facing a fundamental challenge for RL - a decline in revenue. Since 2019, net profit margin has begun to show the resumption of positive dynamics, which is primarily due to competent work with costs. However, sales continued to decline. As I mentioned above, this is the main problem of the company.

(Source: Created by the author)

Asset turnover remained stable until 2017 due to comparable growth rates of revenue and assets on the balance sheet. It is noteworthy that the Fixed Asset Turnover Ratio has been actively decreasing since 2011 due to the company's orientation towards using its own sales channels (active opening of its own stores).

Today we are witnessing a steady downward trend in asset turnover. This is also due to the decline in revenue.

(Source: Created by the author)

The Debt To Equity Ratio of the company has been growing steadily over the past 10 years. The growth of the leverage is accompanied by a decrease in the coverage ratio. At the same time, the Quick ratio remains at a good level (Quick ratio = 2), nothing threatens the company's solvency.

We see a clear trend towards an increase in the debt burden. Obviously, leverage growth played a major role in the resumption of positive ROE dynamics in 2018.

(Source: Created by the author)

The return on equity has a clear negative trend, and the positive momentum in 2018 and 2019 is due to an increase in leverage. At the end of 2020, the company generated 15.7% on equity for shareholders. However, such impressive results are offset by a significant premium to the book value. Today the company is trading at a P/B ratio of 3.7. Taking into account the premium, the investor invests his assets at 4% per annum. In my opinion, this is not enough given the negative dynamics that we have seen in recent years. However, this is a look into the past, and the market lives for the future.

The key question is whether RL will be able to return to revenue growth. If you believe in the success of the transformation that management has undertaken, then you should pay attention to the company, because in case of renewed growth, the market can significantly re-evaluate Ralph Lauren. However, we try to avoid making decisions based on faith.

Why We Are Neutral. Valuation

Within the DCF model, we made a number of assumptions. We assumed that revenues will remain unchanged in the coming years, and margins will slightly improve as part of the business restructuring program. You can see the basic assumptions below:

(Source: Created by the author)

(Source: Created by the author)

At a WACC of 4.9%, we got a fair price of $156.7 per share. Notably, the valuation is comparable to what we heard about in the rumors about the deal with Kering.

In my opinion, the upside potential to the current price is too low to take risks inherent in Ralph Lauren. In addition, if inflation and interest rates rise (fear number 1 for investors today, I wrote about this in my previous article), the valuation will decline even more.

Conclusion

Ralph Lauren is a great American brand. The company has a number of potential growth drivers, including a possible takeover by the luxury industry giant and a course of transformation. However, in recent years, RL has shown a negative trend in financial performance. I'm not sure the company will be able to change this trend anytime soon. If you believe in the success of the transformation, then you should buy, because if growth resumes, the market will change its valuation. However, we try to avoid making decisions based on faith.

The company has a competitive moat in the form of a strong brand. We will monitor the progress of business transformation and its capitalization. However, today RL's valuation is close to fair value. We do not recommend buying Ralph Lauren at the current price.

Analyst’s 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.