There not many clothing brands that have the longevity of Ralph Lauren (RL). The company provides top of the line lifestyle of luxury products as well as products for the fashion-minded aspirational crowd. It has been going strong since its founder, Ralph Lauren, started designing and selling ties in 1967. As many fads have come and gone, Ralph Lauren is still standing. Since its IPO in June of 1997 the stock is up 385 percent for an average annual compounded return of 9.7 percent. For the same period, the S&P 500 index increased a total of 119 percent for an average annual compounded return of 4.8 percent.
Retail has had a tough year so far. The S&P Retail ETF (XRT) is down 2 percent year-to-date compared to the S&P 500 being up 4.8 percent. The University of Michigan Survey Consumer Confidence Sentiment is also slightly down the year. It is at a currently at 81.20, down about 1.5 percent year-to-date from 82.50. Combining the tough retail market with Ralph Lauren’s lower margins for the next few years has led to a decrease of 12 percent in the stock year-to-date. Operating margin is expected to decrease 75-125 basis points for 2015 due to investment in the company’s global retail development and infrastructure, in addition to increased advertising and marketing expense. Keep in mind that the company’s fiscal year starts in April, so we are now in fiscal year 2015. In recent years Ralph Lauren has been buying back licenses to manufacturing its clothing.
Ralph Lauren’s strong brand has helped contribute to its top Business Predictability score of 5/5. A top score indicates that the company has not had an operating loss in the past ten years. Even more impressive is that earnings have increased every year for the past ten years. Not even the Great Recession could stop their earnings from growing. When back-testing 5 star predictable companies, the average company returned an annualized 12.1 for the past ten years. Also only three percent of the companies experienced a loss if held for the full ten years, so the chances of having a loss in Ralph Lauren is very slim.
As far as financial strength, Ralph Lauren ranks 7/10. The balance sheet is strong with a $1.3 billion in cash and cash equivalents compared to $555 million in long-term debt. Its operating earnings are large enough to cover its interest payments 56.5 times. The debt-to-equity ratio is a very low 0.14. Another positive for shareholders is that the company has been buying back shares on a consistent basis since 2008. Shares outstanding have been decreasing at an annual rate of 2.42 percent for the past five years. Buying back shares is a great way to return capital back to shareholders, especially when the company has a 19.24 percent return on equity.
The return on capital (ROC) is at 46.85 percent. ROC is one of the financial ratios that the investing guru Joel Greenblatt pays the most attention to. Ralph Lauren Corp’s high ROC led Greenblatt to greatly increasing his position in the first quarter of 2014. Even with a slightly lower operating margin, it is still much higher than the industry’s mean of 5.47 percent. The superior financial ratios that also include the 19.24 ROE gives the company score of 9/10 for Profitability & Growth.
The tough part about investing in the company is that earnings growth has slowed for the latest year and only increased 5.4 percent for the full year. It is promising that the most recent quarter’s year-over-year earnings increased 22.8 percent. Earnings are not expected to continue at those high rates. The outlook for 2015 only calls for a net revenue increase of 6-8 percent. The average analyst is only expecting a 3 percent increase in earnings for the full year, but they are expecting a much higher 15 percent increase in earnings for fiscal year 2016.
Mr. Ralph Lauren has been instrumental to the company’s success, and he continues to play a critical role as Chairman and CEO. He, or entities controlled by the Lauren family, owns approximately 83 percent of the voting power of the outstanding common stock. With so much at stake, it is likely that the Lauren family will do all they can to retain the value of the company. Although it is a positive to have the successful founder of the company to remain in control, at some point succession planning starts to come to the forefront. The first risk factor listed in the annual report is the following:
“Mr. Ralph Lauren's leadership in the design, marketing, and operational areas of our business has been a critical element of our success since the inception of our Company. Mr. Lauren is instrumental to, and closely identified with, our brand that bears his name. Our ability to maintain our brand image and leverage the goodwill associated with Mr. Lauren's name may be damaged if we were to lose his services. We depend on the service and management experience of Mr. Lauren and other key executive officers, who have substantial experience and expertise in our industry and our business. The death or disability of Mr. Lauren or other extended or permanent loss of his services, or any negative market or industry perception with respect to him or arising from his loss, could have a material adverse effect on our business, results of operations, and financial condition…”
He is now 74 years old, but it will not be impossible for the company to carry on. Companies with a deep-rooted culture and brand continue to succeed such as Burberry (founded in 1856) and Lacoste (founded in 1933).
The current expectations are Ralph Lauren’s earnings are low at only a 3 percent rate for fiscal year 2015. I think that is too low, and they will grow at a slightly higher rate, but no enough to significantly move the stock within the next year and will continue to lag the overall markets. After a slower period of building out it global infrastructure and upgrading their legacy systems to SAP, growth in earnings should revert back to their previous levels due to the re-expansion of margins and continued revenue increases. The average analyst is expecting the earnings growth rate to climb back to 15 percent in 2016. If so, the stock is just slightly undervalued with a fair price 172.49 with a margin of safety of 11 percent according the GuruFocus DCF Calculator. In relation to its P/E ratio, the company is undervalued based on its own historical P/E and comparatively with its peers. Ralph Lauren’s 10-year median P/E is 19.6 and the median P/E for the Global Apparel Manufacturing industry is 24.30. Using the 10-year median P/E, Ralph Lauren is valued at 164.50 with a 7 percent margin of safety. In the long-term it is hard to go wrong with a company with as strong of a brand as Ralph Lauren.