RL | Here’s Why You Could Not Pay Me to Own this Stock

Why You Should Sell The Stock

I think RL is absolutely uninvestable. Seriously, I think it’s evolving into a higher-end CPG version of Abercrombie – which I think is a massive statement. Simply put, it’s a brand that has lost relevance with price points too high relative to faster and better competition – with too high a fixed cost structure to grow earnings at a rate needed to maintain its current multiple. Here’s the problem I have with what Ralph Lauren said last week at its analyst meeting. Aside from otherwise very good disclosure about pieces of the business, the company’s goals are to grow top line low to mid-single digits over the next 5 years. If that wasn’t weak enough, it expects to LEVERAGE SG&A. Answer me this…how can a company fix a broken brand without meaningfully driving SG&A higher? Answer…it can’t. It’s taking up marketing expenses up by a whopping 1.1% of sales. We need to see it up to an 8-10% level for three years running on top of a faster-fashion supply chain to take up relevance and take down costs/prices.

It’s taking a packaged goods approach – which is what you get with a CEO from P&G. He says all the right things and shows extremely well – but not the guy to reignite top line growth to a 10%+ rate needed to make this a great investment once again. Let’s be clear about something, this is not a business model where you start with managing margin. It is 100% about driving the heck out of brand heat and the top line. Daniel attended from my team. But if I was there and heard this growth algo target, I’d have walked out of the room shortly thereafter. This name might be a trade for a quarter or two while the new CEO turns it into P&G, but over a TAIL duration this stock is absolutely uninvestable. The company has mid-60s Gross Margins, which are not sustainable while putting up any degree of investable top line growth. Pick one or the other. Unfortunately you need both for this name to work.

From a modeling perspective, I’m modeling that RL is locked in an earnings annuity range of $6.75-$7.50 for 3-5 years (10-15% below consensus). There’ll be trades around sandbags and false business acceleration – but ultimately this name is worth no more than 15x earnings per my process – there’s $112.5 at the high end with the stock at $142 and yet it’s sitting at 21x pe. In fact, while the business is “P&G’d” over the near term, targets are doable – and if our model is right, beatable – over the next 3-4 quarters. That gives us one year of 11% EPS growth and then 3-4 years of nothing. Keep in mind that 26% of the business is in Europe, where consumer spending is declining without question. There’s a risk I’m thinking management is not baking into its plan.

 

Here's Daniel’s cliff notes from the meeting. [our comments in brackets/italics]

[Well attended considering the Piper Consumer Conference being held in midtown the same day.]

Ralph Lauren kicked it off…

• “Patrice is fantastic.” We are partners [he said that about Stefan Larsson]
• “It’s not fashion, it’s taste and style.” Fashion is over quickly, but style is forever. [he’s right, but styles change, and price points need to respect competition.]
• RL is in the dream business. It’s closer to Disney than other apparel. [yes, he actually said that.]

Patrice Louvet CEO

• Of the 2016 commitments the only one not achieved was the return to sales growth. Focus is now on how to drive quality growth. [been saying that since Roger Farrah].
• In 5 years millennials will be 50% of the market. China will represent 40% of the market. [yes, and millennials don’t wear Ralph Lauren. That’s part of the problem.]
• Digital will grow 5-10x faster than stores. Stores will represent 80% of purchases in some way. [that’s solid – but it’s growing the same rate for competition – and ecomm is margin dilutive (even for RL)].
• 50% of growth will be from core and 50% will be from new categories. [I like this – arguably the best thing I heard all day]
• The five new categories are denim, wear to work, outerwear, footwear, and bags – small leather goods. Expects new categories to be accretive to margins. Each category can be a $100M opportunity.
• RL will expand its presence in China, grow small format stores, and partner with high quality wholesale customers. [bullish]
• RL is very underdeveloped in Germany and Southern Europe. That’s a focus. [Ralph is known as a mid-tier brand in Europe – but with higher end price points – that’s why it hasn’t been growing].
• Digital is expected to grow DD% CAGR and add $500M by 2023. [if it does not beat this it will have lost share in e-comm].
• RL will expand GM, reduce SG&A while increasing marketing (by 1.1%). Marketing spend is 3.9% of sales now and by 2023 expected to be 5% which would add $100M in marketing spend. [Brands like Nike have marketing spend over 10% of sales.]
• By 2023 expect sales to grow $1B and EBIT to grow by $300M – i.e. implied incremental margin on additional sales is 30%. [Sounds aggressive]
• In two years core and iconic products represent 60% of sales. [why not 100%?]
• 30% of SKUs cut and gross profits per SKU increased 22%.[i.e. it currently makes too much stuff people don’t want. Definitely an opportunity – though more of a margin driver than top line]
• The denim market will be $90B in 2019 comprised by $53B in women’s and $37B in men’s. RL’s share is only 2%. [denim and supply was a great idea. Def an oppty for success here. But once an opportunity always an opportunity.]
• Polo denim Q4 sales increased 16% and gross profit increased 28%. [and yet aggregate sales were -7% with -2% EBIT growth]
• Wear to work is a $250B category comprised of $97B in men’s and $153B in women’s. [RL already competes heavily here but did not acknowledge it].
• [RL did not discuss further the other new growth categories – handbags, outerwear or footwear. This was a layup for the company – and it did not even take the shot].
• RL will tailor the offering by channel. For example a popular sweater would be sold in full price  at $395 and $125. For the wholesale channel it would be a lesser quality sweater at $298 and $79.50. For the factory channel two sweatshirts would be priced at $49.90, but have a similar theme as the other channel. [it does this already].
• Customization is important in the full-price retail stores. 20% of polo shirts sold online now are Create-Your-Own. [again…it’s been doing this – to its credit -- and it hasn’t worked.]

Jeff Kusher President of N.A.

• N.A. is an emerging success story. [no, it’s not. It’s simply not in the numbers.]
• $1.6B retail $1.6B wholesale 41 full price and 174 factory 6,848 wholesale stores [failed to address door closures in detail].
• 5% share. #2 in men’s, women’s, and #1 in kids [there’s a reason share is so low – fragmentation is massive and competition at lower price points is fierce].
• Cut off-price by 35%, cut wholesale doors by 25%, closed 41 full-price doors
• Website markdowns cut by 40% [I like this a lot].
• 12 MSAs below fair share including L.A., Chicago, and D.C. [I like the fact that it’s doing the analysis to prove this. #golfclap].
• Wholesale refreshed 80 doors in ’18. Partners splitting the cost of the capex. RL will get to 40% of the doors.
• Will open 12 small format stores. 2,000 square feet
• Launching Chaps on Amazon this summer [KSS bearish]. Chaps price point seem to hit Amazon sweet spot – the reason RL started with Chaps.

Howard Smith President of International [so much of this is simple disclosure around business size, not growth].

• $.9B APAC and $1.6B Europe [Europe is slowing and no acknowledgement there].
• Japan and UK are the 2^nd and 3^rd largest markets. The majority of the international business is in 8 countries.
• International has a higher AUR than the US. [less of a discounting culture].
• Over three years 2% revenue growth led to 19% EBIT growth. [and now it has to comp this.]
• The Asian business is principally in ten countries, seven of which are operated directly. 90% DTC. 1000 POS. 700+ owned and operated.
• Japan is 50% of Asia. Since 2015 revenue grew 6%, EBIT grew 37%, and AUR increased 20%
• Australia has had an 11% sales CAGR. EBIT CAGR has been 250%.
• South Korea had a -2% sales CAGR with EBIT CAGR of 28%. First growth in a decade.
• China in one year opened 40 small format stores. Next year will open 50 stores. 500M revenue target with 150 new stores
• Europe 19 full price stores vs. the competition at 150. So many European markets without a full price store. There is a lot of headroom to grow the store base.

CFO Jane Nielsen

• Excessive discounting mortgages the future of the brand. [#preach!]
• 2019 revenue growth will be -LSD%, but by 2020 will grow positively with margins up slightly.
• RL will return $2.3B to shareholders by 2023.
• GM drivers are less discounts, pricing, international mix, accelerate DTC, and product mix. The offsets will be product cost and investment in quality.
• GM 50-75bps expansion in F19. Stable in the low to mid 60% range.
• EBIT slight operating margin expansion goal.
• RL will be highly selective on M&A.

Q&A

• Millenials approach? It is through focus on product, shopping experience, engagement, and media channels.
• GM? So far the expansion is mostly reduced promos and secondarily higher AUR. In the future half will be from pricing, then geographic mix, and then 1/3 will be category mix. The offset will be inflation and higher quality product.
• The compensation structure for the executive team changed a month ago. It is based on revenue, EBIT, SG&A and quality e-commerce. The long term compensation is based on ROIC.
• RL is one brand expressed through different sub-brands.
• Selling on Amazon had to meet four criteria 1) the brand has to be elevated 2) pricing integrity 3) counterfeits 4) able to interact with the customer. [don't agree that the Amazon customer is a Chaps price point customer]
• Wholesale was 25% of EBIT in 2017 (the last time it was disclosed). Not projecting growth in the algorithm.
• Thinking about future revenue growth in a staggered manner. i.e. 0% then 2%, then 4%.