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Will Ralph Lauren’s turnaround strategy work?

Rayhanul Ibrahim

Ralph Lauren (RL) investors had a rude awakening Tuesday. The retailer’s stock plunged as much as 10% before recouping losses and closing down 2% for the day.

The drop followed Ralph Lauren’s announcement saying it’s cutting its 2017 guidance significantly, and more importantly, unveiling a new turnaround plan, the “Way Forward Plan” – which includes eliminating 8% of its workforce. You might guess the stock drop meant shareholders weren’t impressed.

But as the fashion company’s management added more specifics over a three-hour investor presentation, the stock price climbed back up, and it ended the day off just 2%. Clearly, the market was willing to give the new plan the benefit of the doubt.

So how viable is the turnaround plan? 

Ralph Lauren has enjoyed decades of success as a top-tier luxury clothing company.  Yet its stock price peaked in late 2014, at $185 per share. It now sits around $93, nearly 50% down from the all-time high. As Ralph Lauren showed in its own presentation, the falling stock has matched the decline in its revenue and operating margins.

Ralph Lauren investor presentation

One big factor for the recent margin falloff has been heavy marketing and the addition of a number of new product lines, that attracted little interest from consumers, including watches and handbags. This led to big markdowns and increased inventory. Margins have also been weakened by lower-priced product lines such as Chaps, which has polos that retail for as low as $30. By comparison, the iconic Polo line sells polos for around $100. Another big factor impacting margins was the strong dollar, with international sales being hit hard.

Of course, industry-wide trends for retail in general have not been favorable either—a fact most people who’ve visited a mall in the last year can tell you. Kohl’s (KSS), Macy’s (M) and JC Penney (JCP) had bad earnings reports. American Apparel, Sports Authority, City Sports, Eastern Mountain Sports, Sport Chalet, Bob’s Stores, and Aeropostale have all filed for bankruptcy. Ralph Lauren is suffering in the same market.

Lest you think Ralph Lauren just isn’t cool anymore, the company presented a study by marketing research firm Millward Brown that concluded Polo, Lauren, and Ralph Lauren are still perceived to have high brand value relative to the company’s competitors.

Ralph Lauren CEO Stefan Larsson expanded on the brand value by citing two metrics from the Millward Brown study: power and premium. Power is the expected market share for a product based on brand perception alone, while premium represents how well that product’s pricing matches its perceived brand value. Both Polo and Lauren were ranked No. 1 for both metrics relative to 11 other luxury clothing brands, while Ralph Lauren was No. 1 for power, but No. 3 for premium.  

These three brands also contribute the most revenue of the company’s portfolio and have the highest margins of the company’s 10 brands. Unsurprisingly, the first step in the Way Forward Plan will be to to divert resources away from underperforming brands and focus on the core parts instead.

Ralph Lauren said it will also simplify its organizational structure and work with its supply chain to reduce lead times (the time it takes for a product to get from factory to store) by six months. The latter goal is critical, as excess inventory has been a big problem in the retail world over the past few years, forcing the increased marketing spend.

Expectations for the Way Forward Plan are modest; Ralph Lauren knows it has a lot to claw back. Management expects 2017 and 2018 to show a further decline in revenue and margins. By 2019, it projects sales and margins will start growing modestly. But the main reason the guidance is so conservative is because of the continued macro weakness expected in the sector. In other words, brick-and-mortar retail isn’t making a full-steam recovery any time soon, and Ralph Lauren knows it.

Analysts, however, are still bullish on the company. Credit Suisse, Piper Jaffray, Bank of America Merrill Lynch and Citigroup raised their price targets after the presentation, though Telsey Advisory lowered its target.

Ralph Lauren’s turnaround plan can succeed, analysts say, especially since the company is being candid and conservative about how long the plan will take.  Annew Bank of America Merrill Lynch research note stated that “key initiatives implemented this year should help RL return to growth in FY19.”  It will still be a slow and difficult process, and it will depend partially on factors Ralph Lauren can’t control. But some of Ralph Lauren’s competitors, like Michael Kors (KORS) and Coach (COH), have started to succeed in their turnarounds. It's not unreasonable to think Ralph Lauren can too.

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Rayhanul Ibrahim is a reporting intern at Yahoo Finance.

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