Ralph Lauren Corp. (NYSE:RL) has been particularly disrupted by the pandemic as its global network of retail stores faced shutdowns in the first half of the year. While most locations have reopened, broader weakness in the apparel industry from wholesale distributors continued to pressure the operating environment in the last quarter. Indeed, the stock is down by about 42% year to date, failing to significantly rally with the rest of the market off its lows back in April. That being said, company fundamentals remain positive supported by a strong balance sheet and signs that conditions are set to recover through next year. We are bullish on shares of RL which offer attractive value at the current level for what remains a high-quality company with a market-leading brand.
(Source: Company IR)
Q2 Earnings Recap
Ralph Lauren reported its fiscal 2021 Q2 earnings on October 27th with non-GAAP EPS of $1.44, which was $0.57 ahead of expectations. On the other hand, a GAAP EPS loss of -$0.53 reflected a $191 million restructuring and impairment charge with the company announcing some organizational realignments. Revenue of $1.2 billion in the quarter was slightly lower than consensus estimates and represented a decline of 30% year over year given continued disruptions related to the pandemic.
(Source: Company IR)
On the other hand, the company has seen a sequential improvement compared to the depths of the pandemic in the prior quarter when sales declined by 66% y/y globally. In North America, sales are still down 38.4% y/y pressured by a 46% decline from wholesale channels. The Asia region has favorably outperformed with sales down just 7.3% y/y. Management noted that China, an important market for the company, has already returned to pre-pandemic growth levels.
The gross margin in the quarter at 67% was up from 61.5% in the period last year driven by the product mix and a higher average unit revenue “AUR”. The company made some efforts to reduce costs with several savings initiatives including employee furloughs helping overall operating expenses decline by 19% y/y. Still, excluding the impairment and restructuring charge, the company reports an adjusted operating margin of 12.6%, down 230 basis points from last year, consistent with the weaker sales.
On the balance sheet, the company ended the quarter with $2.4 billion in cash and investments against $1.6 billion in long-term debt. The net cash position and overall solid liquidity position highlights the strength of the company that is well-positioned to navigate the current challenges.
2021 Strategic Realignment Plan
One of the key developments this quarter was the announcement of its “Fiscal 2021 Strategic Realignment Plan”. The company intends to optimize its real estate footprint across distribution centers, corporate offices, and retail stores to focus on efficiency along with headcount reduction. The efforts are intended to save between $180 million and $200 million starting in fiscal 2022. The plan is in the context of a broader five-year framework meant to drive sustainable, long-term earnings growth.
(Source: Company IR)
The company is moving the “Chaps” apparel brand to a licensed model. The impact here is to remove the brand’s revenue and inventory impact off the company’s balance sheet and simply receive a fee from distribution partners that can flow directly into operating income. The strategy here is to focus more on the higher-value Ralph Lauren namesake while running a more streamlined operation. From the conference call:
Today, we announced that we are transitioning our Chaps business to a fully licensed model. This shift is consistent with our long-term strategy from several aspects. First, it will enable us to put even greater focus on elevating our core namesake brands in the marketplace. Second, it will reduce our total direct exposure to the North America brick-and-mortar department store channel, notably the more moderate tiers. And third, this move will create incremental value for the company by setting up Chaps to deliver on its potential with an experienced partner in the sector that is focused on nurturing the brand.
Management Guidance and Consensus Estimates
While management is not offering forward guidance given ongoing uncertainties with the pandemic, the message is that it expects an improvement in the second half of its fiscal year through 2021 with an upside to margins supporting cash flow and earnings. The idea is that as conditions stabilize, the company can reclaim its growth trajectory in key markets and leverage earnings higher from the recent strategic initiatives.
In terms of consensus estimates, including the trends from Q1 and Q2, RL is expected to reach $4.47 billion in revenues representing a decline of 27.5% y/y. The adjusted EPS estimate of $1.75, if confirmed, would be a decline of 74% compared to fiscal 2020. Looking ahead, better comps next year can drive a forecast for 27% revenue growth for fiscal 2022 while EPS can rebound strongly to $6.07.
(Source: Seeking Alpha)
Analysis and Forward-Looking Commentary
Among apparel retailers, Ralph Lauren is one of the strongest brands in our opinion based on a long history of quality products and innovations in design. We are confident the company will not only survive the pandemic but also has a long-term future.
In terms of valuation, considering the current consensus EPS estimate for next year, the stock is trading at a one-year forward P/E multiple of 11.3x. While there are significant uncertainties about whether RL may be able to achieve that level of earnings, the stock appears cheap in the context of an average historical P/E ratio of 21x over the past decade. Even excluding the period between 2017 and 2018 when earnings were pressured through a restructuring charge that year, we estimate a normalized P/E multiple for the stock around 15x.
The point here is that if RL can stabilize in this operating environment and the macro conditions improve as the pandemic gets under control, the company can generate consistent profitability. To the upside, we are bullish that the strategic initiatives and realignment plan in place now can drive operating margins higher, which could translate into a higher valuation multiple for the stock long term.
Overall, we rate shares of RL as a buy with a price target of $85 representing about 23% upside from the current level. Monitoring points going forward will be the continued recovery improvement in comparable sales while the Asia region could deliver positive growth. Risks here beyond a deterioration to the macro environment include the potential that the pandemic outlook worsens forcing a new round of lockdown measures and retail store closures in key cities in the U.S. The potential that the company underperforms expectations in the upcoming quarters could force a revision lower to earnings estimates.
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Disclosure: I am/we are long RL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.