Ralph Lauren (NYSE:RL) is one of the crown jewels in retail. It is well capitalized with a net cash balance sheet and has historically earned a premium valuation. Given its compounding history, the premium valuation is justified. Due to short-term factors, the stock price has dropped over 40% from recent highs and now trades at absolute valuation levels last seen shortly after the financial crisis. It is a rare opportunity to buy a well-managed, well capitalized, owner-operator at an attractive price.
Although retail has historically been an area that Third Avenue Management (Trades, Portfolio) (TAM) shies away from, RL is an exception. It meets our three pillar criteria as it is a credit worthy compounder trading at a discount to NAV. Over the past five and ten year periods, RL has grown book value (including dividends) 11% and 13%, respectively. It is a blue-chip asset with a more stable operating history than most players in the space. For example, sales only declined marginally in 2009, following the financial crisis. Although it could be categorized as a retail company, considering that roughly half of RL’s sales are wholesale/licensing and its brand strength, it’s more comparable to Nike than a typical retailer.
Besides macro concerns about an economic slowdown, company specific issues have soured RL’s near-term outlook. We have assessed these risks and feel it is a classic case of investor short-termism. First, the strong USD has impacted sales. One-third of RL’s sales are from outside the US, so currency translation has pinched sales and margins. Also, 20% of RL’s sales come from foreign tourists shopping in the US. Those sales have been pinched as tourists are choosing to stay home as the costs of traveling to the US have risen with the stronger USD. RL continues to experience double digit same-store sales growth in flagship stores overseas, so it does not appear to be a brand problem.
Another major factor impacting RL is the implementation of its Global Reorganization Plan (GRP). Management is investing for growth by creating a brand based operating structure, implementing a global SAP system (US completed and Europe in-process) and expanding its global footprint and internet presence. All initiatives make sense in the long-run, but have been costly in the short-run. The slower than expected sales and additional costs have pressured margins, creating investor angst. Management projects cost savings of $100 million per year once the initiatives are completed later this year. Investors are struggling to see through the near-term noise which has created a worst-case scenario valuation.
A final catalyst is the hiring of CEO Stephan Larsson. Larsson is a young, ambitious retail executive who had highly successful stints at H&M and Old Navy. With Ralph Lauren now 75 years old, Larsson’s hiring makes strategic sense. Lauren will remain a creative force at the company, but Larsson’s expertise in understanding the fast fashion landscape (H&M) and turnarounds (Old Navy) might be the shot in the arm RL needs.
In summary, we feel that the favorable long-term prospects heavily outweigh the near-term concerns embedded in RL’s current valuation. Higher sales, a weaker USD and lower GRP costs can all contribute to a brighter outlook for RL’s operations. With the additional benefit of a highly motivated new CEO, the pace of change has probably been accelerated.
From the Third Avenue Value Fund 1st quarter 2016 letter.
