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Is Ralph Lauren the Next Great Retail Stock?

Leo Sun, The Motley Fool

Shares of Ralph Lauren (NYSE: RL) rallied 8% on Feb. 5 after the apparel retailer's third quarter numbers topped Wall Street's expectations. Its revenue rose 5% annually (6% on a constant currency basis) to $1.73 billion and beat estimates by $70 million. Its non-GAAP EPS climbed 14% to $2.32, topping expectations by $0.17.

Ralph Lauren expects its revenue to rise slightly on a constant currency basis for the full year, and analysts expect its revenue to rise 1% this year. That growth rate sounds anemic, but it would represent a significant improvement from its 7% decline last year.

A Ralph Lauren marketing campaign.

Image source: Ralph Lauren.

Is Ralph Lauren finally poised for a comeback? Or will it face fresh headwinds in the brutally competitive apparel market?

The key facts and figures

Ralph Lauren has struggled with declining mall traffic and the rise of fast fashion retailers like Zara over the past few years. It hired Old Navy chief Stefan Larsson to succeed Lauren as its CEO to revive the brand in 2015, but creative conflicts between Larsson and Lauren led to Larsson's resignation in 2017.

Larsson's successor, CEO Patrice Louvet, fared better. Under Louvet, the retailer reduced its online promotions to protect its brand appeal, shortened turnaround times for new products to counter fast fashion rivals, and expanded heavily into Asia to reduce its dependence on the weaker North American and European markets. Those efforts paid off as its comps growth improved across all three regions.

 

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

North America

(10%)

0%

(3%)

1%

4%

Europe

(8%)

(6%)

(8%)

(4%)

4%

Asia

3%

4%

6%

6%

4%

Comparable store sales growth, constant currency basis. Source: Quarterly reports.

During the third quarter, Ralph Lauren attributed its improvement in North America to a 21% jump in digital commerce revenue, which offset the flat comps growth at its brick-and-mortar stores and a decline in its wholesale revenue.

In Europe, Ralph Lauren's brick-and-mortar comps rose 3% as its digital commerce sales climbed 13%. Its wholesale revenue also surged 20% on a constant currency basis. However, the region's numbers were inflated by a shift in the timing of its shipments, which is expected to negatively impact its fourth quarter sales.

A Ralph Lauren marketing campaign.

Image source: Ralph Lauren.

In Asia, Ralph Lauren posted "strong performance across every market," with growth in both brick-and-mortar and digital commerce sales. It generated 19% constant currency sales growth in China, where it directly sells its products on Alibaba's Tmall, JD.com, and Tencent's WeChat.

52% of Ralph Lauren's revenue came from North America during the quarter, compared to 54% in the prior year quarter. Europe and Asia accounted for 24% and 16% of its revenue, respectively.

Expanding margins and rising earnings

Ralph Lauren's adjusted gross margin rose 90 basis points annually to 61.6% during the quarter. This indicates that its efforts to curb promotions and off-price sales in its wholesale channel (especially in North America) are paying off. It's also prevented the company from falling into the trap of using markdowns to drive sales.

Its adjusted operating margin rose 70 basis points to 13.9% as expanding margins in North America offset slight declines in Europe and Asia (in constant currency terms). Ralph Lauren expects its full-year adjusted operating margin to improve 60 basis points, compared to its prior forecast for a 40 basis point gain.

Ralph Lauren also bought back 400 million shares in the first three quarters of fiscal 2019, and plans to spend a billion dollars on buybacks through fiscal 2020. Analysts expect the company's rising margins and buybacks to boost its earnings by 13% this year, which is a solid growth rate for a stock that trades at 17 times forward earnings. Ralph Lauren also pays a decent forward yield of 2.2%.

A good retail stock, but not a great one

Ralph Lauren is one of a handful of U.S. apparel retailers that are surviving the "retail apocalypse". But it still isn't that compelling as an investment, since other apparel stocks with higher growth estimates are trading at lower valuations.

American Eagle Outfitters (NYSE: AEO), for example, posted 15 straight quarters of positive comps growth, and analysts expect its earnings to rise 27% this year. Yet AEO trades at just 13 times forward earnings, and pays a forward dividend yield of 2.6%. AEO also has a strong presence with younger female shoppers with Aerie, which regularly generates double-digit comps growth. Ralph Lauren lacks that kind of secondary growth engine.

Ralph Lauren is a good retail stock right now, but it's not a great one. The stock is running a bit hot after rallying 20% this year, so I'd stick with cheaper plays like AEO until Ralph Lauren cools off to lower multiples.

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Leo Sun owns shares of JD.com and Tencent Holdings. The Motley Fool owns shares of and recommends JD.com and Tencent Holdings. The Motley Fool has a disclosure policy.