This was a decent quarter for RL. Yah, I get it, the company put up a big headline beat – but half of it was a lower tax rate, and the reality is that in this ‘killer’ quarter (as defined by the market’s reaction), the top line only grew by 1.4%, and EBIT was up a whopping 2.8%. The company is making strides in lowering promotions hence taking up AUR (up 6% this quarter – though transactions were down), and is also succeeding on the margin online – Digital comp was up teens% this quarter after #failing online more often than not over the past two years. But seriously, should we be celebrating such sub-par EBIT growth for a brand that is half as relevant as it was a decade ago? The stock is not egregiously expensive at 15x earnings and 10x EBITDA, but you won’t catch me paying those multiples for such a slowly growing P&L. This company needs to take up its marketing spend by 2-3x and jack up its capex (things Stefan Larsson wanted to do before he was fired). We need a focus on giving the brand a material shot in the arm such that it’s once again relevant to a younger generation. But instead the company is following a P&G growth algorithm – sorry but that doesn’t work in fashion. You won’t catch me getting behind RL until I’m convinced that it could grow the global portfolio at a high single digit rate – which seems like a pipe dream based on the anemic growth numbers we see today. Unfortunately, I think that the consensus has it about right for FY21 (Mar), otherwise I’d be outright short this name. For now it remains on our short bench, with a clear bias to the downside.
OVERVIEW OF THE QUARTER
RL reported EPS of $2.86 vs. consensus of $2.45. It was a large headline beat driving shares to the highest levels since May.
- A lower tax rate was a $.24 benefit in the quarter.
- The remainder of the beat was due to better gross margin expansion somewhat offset by higher SG&A spend.
- The earnings algorithm was the weakest in seven quarters as most of the EPS growth was driven below the line.
- Concern about the potential impact from the coronavirus spreading in China colored sentiment into the earnings report. The contagion concern remains, but the Q3 results seem to suggest to bulls the impact in China can be weathered.
- Hong Kong was a relatively insignificant -50bps impact on the overall top line, but that was driven by the disruption from protests and not the coronavirus.
Outlook
- Management now expects revenue to be better than the low end of the previous guidance range and operating margins to be at the high end.
- Guidance parameters will not pull Q4 consensus down. We took our EPS estimate up slightly to $1.08 vs. consensus previously at $.98.
- FQ4 has an easy top line comparison with the Easter shift last year, but the headwinds from Hong Kong, coronavirus, and a $10mm tariff impact are all more difficult sequentially.
- Our outlook for F2021 is only $.05 above the consensus EPS estimate of $8.55.
North America
- North American revenue increased slightly. Comps grew 4% with digital up 6% and stores up 4%.
- AUR in the stores increased 8% as it lapped a 7% increase last year, highlighting a significant price and mix increase led by factory stores. It’s a notable divergence relative to the overall outlet channel that continues to struggle to drive traffic to see AUR increase that much.
- The headwind to North America was in wholesale which was down 8% in the quarter compared to -6.5% sequentially. The headwinds both secular and calendar related were well known this quarter and the company was impacted, but not worse than feared.
- Wholesale shipments to the off-price channel was down DD% in the quarter, lapping a DD% decline last year.
- EBIT margins for the region contracted 30bps due to the pressures in wholesale.
Europe
- Europe is the best performing region for the company currently with revenue growing 5% in constant currencies.
- Wholesale in Europe increased 5% in constant currencies.
- Retail comps grew 3% with stores up 2%. Digital comps grew 15%, accelerating 2% sequentially.
- Operating margins expanded 300bps driven by better gross margins and SG&A leverage.
- After Q4 the comparisons are much more difficult for a similar level of operating margin expansion in F2021.
Asia
- Revenue in Asia grew 5% with a 3% negative impact from Hong Kong.
- A pull forward of a friends and family event helped offset some of the declines in Hong Kong. The decline in Hong Kong was offset by growth in mainland China exceeding 30%.
- Comps decreased 1%, but digital comps increased 36%.
- Hong Kong is expected to have a 5% negative impact in FQ4.
- Operating margins contracted 70bps in constant currencies driven by SG&A deleverage in China.
- Hong Kong had a -200bps impact on operating margins for the region.
Total Company Margins and Balance Sheet
- Total company gross margins expanded 60bps.
- AUR increased 6% in the quarter with higher pricing, better mix, and lower promotions.
- The tariff impact in Q4 is expected to be $10mm and for F2021 the impact is expected to be $12-15mm.
- SG&A grew 2.4%, the fastest YY growth in four quarters and deleveraged 50bps.
- It’s a start, but we believe Ralph Lauren needs to seriously up its marketing spend. The 16% growth in marketing spend in FQ3 was driven more by a timing shift than a real step up in marketing commitment by management.
- Inventories decreased 1%, the first YY decrease in seven quarters.
- The share count was 6.7% lower YY. The company spent $98mm repurchasing shares in FQ3. With the company still planning on repurchasing $600mm in the fiscal year it will repurchase $100mm in FQ4.
