Ralph Lauren: A Buying Opportunity?

After a 20% price drop, is there a good reason to buy its shares?

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Feb 05, 2016
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What happened?

Here is a succinct title by MarketWatch that summarized this recent roughly $2 billion market capitalization loss:Â “Ralph Lauren's (RL, Financial) stock tumbles after missing sales expectations, cutting outlook.”

Should investors now just forget any investment thesis they had prior to purchasing Ralph Lauren and look forward to cutting their tax bill this early?

Six facts about Ralph Lauren:

  • Founded by its recently retired CEO Ralph Lauren in 1967 (~49-year-old company).
  • A Standard & Poor's 500 component.
  • Recent quarter sales of $1.9 billion ($2 billion a year earlier).
  • Recent profits of $131 million ($215 million a year earlier, 39% reduction).
  • Profit margin of 7% (11% a year earlier).
  • TTM total debt of $1 billion (35% increase year on year with D/E ratio of 0.27).

Ralph Lauren CEO Stefan Larsson's knee-jerk reaction from Thursday’s earnings announcement provided some clues for 2016’s performance. Highlights were as follows:

  • Larsson said he wants to focus on fewer brands.
  • Ralph Lauren’s pricing and distribution business has lately turned more challenging. Larsson said one solution could be better inventory management to prevent goods from piling up on shelves and being marked down.
  • Further, the company has lowered its 2016 guidance and now expects revenue to decline 3%Â from its previous estimate for revenue to be unchanged from the year earlier.

Looking at these figures can induce myopia and pessimism. Nevertheless, maybe there is value hiding beneath Mr. Market’s punishing Ralph Lauren’s shares today.

Knowing that historical performance does not transfer to the future, I still sort to it to fulfill most of my investment checklist.

Competitors

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% Market share by revenue among mentioned competitors (FOREX 1 SEK=0.12 USD)

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Amazing lead by Hennes & Mauritz (HNNMY, Financial).

The numbers:

Profit growth

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(Michael Kors [KORS] data was only available from 2011 onward.)

Michael Kors (pink) appeared to be an exemplary profit growth company since it enlisted in 2011. Removing it from the current group revealed the following chart:

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Further, I had to separate Hanesbrands (HBI, Financial), Michael Kors, Gildan (GIL, Financial) and PVH Corp.'s (PVH, Financial) growth numbers secondary to volatility and above-average performance (for Michael Kors). There are three things that can be observed in this chart:

  • Peer profit growth (red line) has been declining for the past five years but not as alarming as what happened in the Great Recession.
  • Along with Michael Kors, Under Armour (UA, Financial) also had an exemplary run in demonstrating above peer growth at 35% five-year average vs. 28% in its peers.
  • Both Ralph Lauren and Hennes & Mauritz are "making it," but VF Corp. (VFC, Financial) and Coach (COH, Financial) have succumbed to negative profit growth in recent years.

On the other hand, here are Hanesbrands, Gildan, Michael Kors and PVH’s growth numbers:

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DuPont’s return on equity model

I used DuPont’s model to assess three different metrics at once (profit margin, financial leverage and asset turnover ratio), at the same time determining each company’s return on equity. More discussion of the model on this link.

In summary, I use these criteria when using the model:

  • Profit margin: up or stable.
  • Financial leverage: down or stable.
  • Asset turnover: up or stable.
  • Return on equity: up or stable, Buffett would require more than 14% (in 1972):Â Source.

The asset turnover is fitting to use in comparing these companies recalling that Larsson once mentioned that he wants to have better inventory management. Therefore, a high asset turnover (inventory is part of current assets in balance sheet) is indicative that a company is efficient in generating more revenue per asset.

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DuPont’s ROE 10-year chart revealed the following:

  • Hennes & Mauritz and Michael Kors have been outperforming the peer average. Hanesbrands and Coach were almost included in the outperforming companies, but exhibited volatility (Hanesbrands-orange) and recent underperformance (Coach-red).
  • Ralph Lauren and others have underperformed this metric.

Dissecting the model further gave the following:

Profit margin

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Michael Kors, Coach, Hennes & Mauritz and Gildan Activewear are the only companies who exceed the peer average in profitability. Coach appears to be experiencing some difficulties achieving the same level of profitability as it had in the past decade.

Financial leverage

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Hanesbrands, PVH, VFC and recently both Coach and Under Armour have risen above peer average in terms of their leverage. High financial leverage can induce high ROE, which would not be good if a conservative investor is trying to look for low-leveraged companies.

Other companies not mentioned were not as leveraged. Ralph Lauren and Michael Kors appeared to have the lowest leverage among the group.

Last, asset turnover ratio:

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Hennes & Mauritz, Michael Kors, Under Armour have exhibited above-peer asset turnover performance over the past decade (Kors data only available from 2011).

Free cash flow in USD millions

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Hennes & Mauritz, VFC and Coach had great capabilities of producing more cash for their shareholders in the past decade. Ralph Lauren, on the other hand, performed within the peer average.

Total cash returned to shareholders for the past decade (dividends+sharebuybacks):

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Hennes & Mauritz has been an outstanding component in the group so far. Along with it, Coach, VFC and Ralph Lauren have provided more to their shareholders in the past decade (Kors had only been a public company in 2011).

Current dividend yield

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Current P/E ratio

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Clearly, Under Armour has been a "darling" of Mr. Market. Other than that, Michael Kors, Hennes & Mauritz, Ralph Lauren and PVH have lower P/E valuations compared to the S&P 500’s, thus probably presenting some value.

In conclusion, the recent collapse in Ralph Lauren’s price does indicate that Mr. Market has a bipolar disease. Unfortunately, long-term Ralph Lauren investors have experienced the depressive side of him. Further, the facts above were not enough to force me to perform more numbers research in Ralph Lauren. The company may be undervalued compared to S&P 500 as of the moment, but given its "low: current dividend yield (despite the recent 20% price collapse) and the recent change in CEO, I refrain from purchasing its shares. Analysts will probably label this call a “hold.”