Management matters.
Even if a company owns one of the greatest brands in its industry, decline is inevitable when senior management neglects the basics of executional excellence and financial discipline. Case in point: Ralph Lauren Corp. (RL, Financial).
The October 2013 departure of Roger Farah from the role of president and chief operating officer preceded a disastrous collapse in Lauren’s fundamentals. The stock trades at 50% of its 2014 high, and income-oriented investors should take note of its safe dividend, now yielding an unprecedented 2%. Unfortunately, consensus estimates don’t expect Ralph Lauren to re-attain fiscal 2016’s level of non-GAAP adjusted EPS ($6.36) until 2019, at the earliest. Regaining prior peak earnings (from 2014) of $8.43 will take longer.
Profit margins and inventory controls deteriorated since late 2013, the period during which Ralph Lauren has lacked a president or chief operating officer. Keep in mind that it is those two roles that are generally held most responsible for the “nuts and bolts” of day-in, day-out execution of any company’s business plan. And for a marketer and retailer of branded consumer goods, few financial metrics offer better insight into the state of operations than margins and inventories. They suggest a case of reckless growth, a classic error at publicly held companies eager to show shareholders a steady pace of sales expansion. In Lauren’s case, that drive led to over-proliferation of its brands in the wholesale division, which sells through retailers like Macy’s (M, Financial) and Nordstrom (JWN, Financial). Product piled up on shelves, inventories exploded, and margins crashed.
Judging from the company’s public filings, it’s apparent that during 2013-16, more executive responsibility was concentrated into the hands of founder, chairman, and CEO Ralph Lauren. Lauren is globally renowned as a man of creative talent, vision and ambition. But given the subsequent results, it’s safe to say that “CEO Lauren,” were he not in control of 81% of Ralph Lauren’s voting power, would have been terminated by even the most brain-dead board of directors.
To his credit, Lauren hired outsider Stefan Larsson as CEO and president last November. Larsson built an enviable record of success as president of Gap’s (GPS, Financial) Old Navy division, and as head of global sales at fast-fashion powerhouse Hennes & Mauritz AB (HM B). More importantly, Larsson’s ability to attract top-grade executives to Ralph Lauren in recent months has been nothing short of astonishing:
New CFO Jane Nielsen just jumped ship from Ralph Lauren’s primary rival, Coach (COH, Financial).
New Senior Vice President of Supply Chain & Inventory Management Bill Campbell just left Amazon (AMZN, Financial), the most celebrated growth stock in all of U.S. retailing, to work at Ralph Lauren.
New Group President for the Americas region, Jeffrey Kuster, worked at HSN Inc. (HSNI), Fruit of the Loom and VF Corp. (VFC, Financial).
The willingness of all-star talent to leave such respected companies for work at Ralph Lauren settled any questions I had about the durability of Lauren’s brand power and cachet. Given our premise that management matters, one has to be encouraged about Ralph Lauren’s prospects for pulling off a recovery.
Besides the infusion of new ideas and talent, Ralph Lauren is blessed with another advantage that many turnaround candidates lack: a rock-solid financial foundation. Despite the mismanagement and over-expansion of recent times, Ralph Lauren has generated free cash flow for 15 consecutive years. And the company’s A-rated balance sheet boasts something that’s all too rare today, outside of the technology sector: a net cash position. That is, Lauren’s stockpile of cash and liquid marketable investments could be used today to eliminate all short-term and long-term debt, with extra proceeds left over. Ralph Lauren’s board of directors deserves credit for protecting the balance sheet throughout the recent operational stumbles. Larsson’s turnaround campaign will be difficult, but a balance sheet this strong makes Lauren’s turnaround more a question of “when” than “if,” and shareholders should take comfort in that.
The biggest risk could be Ralph
It’s well documented that former CEOs who remain on their companies' boards can find it difficult to step back and not “meddle.” That risk is certainly compounded when the ex-CEO happens to be the company’s iconic founder! Unfortunately, Mr. Lauren has shown a reluctance to hand the reins of command to his chosen successor. After hiring Larsson, Lauren changed his own title from chairman and CEO to executive chairman and chief creative officer. That word, executive, stands out like a flashing yellow “caution” sign on the highway. It suggests that the authority and power to execute Ralph Lauren’s turnaround strategy lies not with Larsson but with some ambiguous combination of Lauren and Larsson. This situation is the single biggest risk to a recovery at Ralph Lauren. When difficult and unpleasant decisions need to be made, any organization can grind to a halt without a clear chain of command. My hope is that executive responsibility is placed, clearly and unambiguously, into Larsson's hands.
Conclusion
For investors willing to bet on this extremely cheap stock (as I have), I recommend a hefty dose of patience. Getting Ralph Lauren back to its mid-teens profit margins of the past, and its valuation multiples of the past, will take several years, not quarters. On the bright side, our wait will be cushioned by the 2% dividend yield, which beats the return on a 10-year Treasury bond. While the odds of recovery look stacked in our favor, a breakdown in the chain of command could hinder or, at the very least, postpone the new team’s efforts. What should investors watch for, besides the normal earnings reports? Make sure these talented newcomers actually stick around. Keep an eye on the 10-K’s roster of executive officers and on any press releases regarding personnel moves.
Disclosure: I am long Ralph Lauren, but have no positions in any other companies mentioned.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from gurufocus). I have no business relationship with any company whose stock is mentioned in this article.
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