We said earlier this summer that we liked RL as a TRADE into today’s print. Fundamentally, the call played out – though we’re about flat on the stock.
Let’s get one thing out of the way…this RL quarter was horrible. Yes, it beat muted EPS expectations by $0.10. But revenue was down 5.3%, gross profit -7.1%, SG&A UP +4.3%, and EBIT/EPS down ~40%. Think it can’t get any worse? Think again, the cash conversion cycle is sitting at 171 days, which is 26 days worse than last year. Finally, capex is up 25% this year, which is the icing on a really bad tasting cake. Put ‘em all together – P&L down 40% and Balance Sheet +25%, and you get RNOA of 13%, down 1,000bp vs last year.
Then why are we incrementally warming up to RL? When it comes to consumer brands and retailers, some of the best longs we’ve seen (ones that double, and then double again) start with
a) positive rate of change in the balance sheet, which frees up cash to…
b) improve margins while investing in the content/Brand, and ultimately…
c) accelerate the top line. The stock will usually seem expensive early on in this process, and that’s where RL is today, as it’s trading at 17x a declining earnings stream.
We’ll very rarely give any company the benefit of the doubt for being able to turn such a value-eroding algorithm around – but Ralph Lauren is perhaps one of them. The reality is that it is a brand with an aggregate value at retail of $15bn, and as the company positions its resources around its core assets on a global scale, we should see growth return, and Brand footprint go through $20bn. Specifically, as it relates to the criteria above…
a) on the Balance Sheet we should see Capex coming down next year by 25%, or about $100mm as spending on SAP, which should subsequently take the Cash Cycle down by a minimum of 25 from here (that’s $200mm in cash)
b) on the Margin line, we should see a lift from the 11.5% where it’s targeted to come in for FY16. For the record, that’s the lowest margin level –by a third – since 2005 when it faced dilution from integrating licenses(most by Jones Apparel Group).
c) better productivity in company-operated stores and e-commerce alone could add $3bn to consolidated sales – nevermind better efficiency in wholesale doors.
When all is said and done, in 2-3 years we could be looking at $9.5bn in sales, 15% EBIT margin and $11-$12 in EPS. The CAGR that would require such growth (25-30%) would arguably support a 20-25x multiple on $11+ in earnings. That’s when RL becomes a two-bagger.
All that said, we have to get comfortable with one thing, and one thing alone – and that’s management. We outlined the risks to that part of the story in our recent vetting book [LINK: CLICK HERE]. Aside from the fact that RL has the seventh oldest CEO in the S&P – and one who is more active today than ever in the day to day operation of the company, there are six new divisional presidents who need to learn their own job as well as hire and subsequently motivate teams of expensive people to be productive. That’s not a 1-2 quarter phenomena.
We’re going to take RL up another notch on our Idea List, and will further vet the management angle before adding it to our Best Ideas.