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Why Some Apparel Giants Are Not Worth Purchasing

October 11, 2013 | About:
Patricio Kehoe

patokehoe

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In order to operate in the apparel manufacturing industry today, firms must face a highly competitive marketplace and low customer switching costs. Therefore companies such as Ralph Lauren Corp (RL) and PVH Corp (PVH) seek to strengthen their brands, acquire new ones, expand globally and diversify their distribution channels. How these firms manage to minimize risks and improve profit margins will depend on the execution of these strategies.

A Single Solid Brand

Ralph Lauren offers a broad range of apparel and accessories. Distribution is channeled through specialty retailers, a chain of company-owned retail stores and department stores such as Macy’s. The company has a solid growth record, achieved by making smart acquisitions and driving internal growth. Apart from owning some of the strongest brands in retail, the firm has been expanding globally. Although Ralph Lauren has a good long term outlook, short-term risks could affect stock prices.

One of the risks is over reliance on a single customer in the wholesale segment. Macy’s was the recipient of 25% of wholesale products, making it Ralph Lauren’s most important customer. Should the department store decide to cut its orders, the firm would be hit by a large decline in sales. Furthermore, a lack of diversification of the company’s portfolio makes it prone to fashion risks and limits-scaled operations. Also, Ralph Lauren purchases merchandise from other manufacturers, because it does not own any manufacturing facilities of its own.

Despite those risks, the company has good long-term prospects. Investments in e-commerce, international growth and a competitive advantage, derived from a strong brand, are key elements for the firm’s top-line growth. Ray Dalio of Bridgewater Associates, however, doesn’t seem to be satisfied by the high returns on invested capital and narrow economic moat the company has to offer. Initiatives related to ensuring apparel differentiation and targeting international markets (such as Japan and South Korea), have not impressed the guru, who sold his entire stake in the firm. Although Ralph Lauren has been delivering great results over the past decade, the lack of diversification in terms of brands and customers, along with its dependence on outside manufacturers, could expose the firm to short term risks. Hence, I would hold on this stock.

Diversification and Smart Purchases

PVH owns brands such as Calvin Klein, Van Heusen, Arrow and IZOD. The acquisitions of Tommy Hilfiger in 2010 and Warnaco Group in 2012 have led to increasing sales, and are expected to deliver long-term growth. Smart acquisitions and a diversified portfolio, which includes designer lifestyle apparel brands and heritage brands, are the reason the company has been delivering positive results. As a sign of his optimism, investment guru Scott Black of Delphi Management increased his holdings in the firm by 16.55%.

Unlike Ralph Lauren’s internal growth model, PVH has relied heavily on acquisitions. The purchase of Calvin Klein in 2003 was a success, doubling the company’s global retail sales. And the addition of Tommy Hilfiger 2010 to the firm’s portfolio for $3 billion, increased revenue two-fold. These two complementary brands will produce annual growth rates of 8% to 10% according to management projections. In addition, the purchase of Warnaco Group has expanded the company’s geographic reach even further, achieving higher penetration of the Asian and Latin American markets.

PVH’s diverse portfolio includes a large number of company-owned brands, licenses, and apparel categories that provide scale and strength in the retail business. Although the company must face changing consumer tastes and limited retail visibility, it has a strong multichannel presence, popular brand licenses, and a leading market positioning in several categories. With a very stable core business, in the men’s dress shirts and neckwear segment, and a middle-age customer base, PVH is less exposed to fashion-trend oriented consumers. Although the firm’s financial situation is not as solid as Ralph Lauren’s, due to the acquisition it has made over the past years, I feel bullish about this stock.

Great Outlook, But Steep Premium

PVH’s main advantage over Ralph Lauren is its diversified portfolio. The acquisition of strong global brands has allowed the firm to grow internationally with ease. Also, the stability of its core business means that PVH is less exposed to fashion related risks. However, the apparel giant is trading at a very high price premium relative to the industry average. Although I feel very optimistic about PVH’s future, the time for entry has passed. Ralph Lauren has a much smaller premium, yet it is more exposed to industry risks and the shedding of stock by investment gurus is worrisome.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

patokehoe
A fundamental analyst at Lone Tree Analytics

Rating: 3.8/5 (4 votes)

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