Polo Ralph Lauren (RL)

TOP CONTRIBUTORS

Anichya G

Jason Mercer

Shawn Woodhull

Polo Ralph Lauren (NYSE: RL) is a premier global player in the design, distribution and marketing of lifestyle products such as men’s, women’s and children’s apparel, accessories, fragrances and home furnishings. RL reported just over $4.9 billion in revenues in 2010 (fiscal year ended April 3, 2010), down 1% from 2009..^[1] The largest part of its revenues come from its wholesale division, which sells Ralph Lauren products to department stores such as Macy's Inc. (M) and J.C. Penney (JCP). RL's product lines range from relatively inexpensive brands (such as Chaps) to expensive, exclusive pieces (Ralph Lauren Collection).

Consolidation amongst department stores has resulted in an increase in the purchasing power of department stores at the expense of brands such as Ralph Lauren. Fewer department stores means each store has more power over suppliers. Also, the fact that Polo Ralph Lauren sells its goods internationally exposes RL to exchange rate risk. Fluctuating exchange rates have had a substantial impact on sales: a gain of $1.6 million in fiscal 2009 and a net loss of $2.2 million in fiscal 2010.^[2] In addition, new wealth in Asia has led RL to increase control over its own brand in that region.

Business Overview

Business Financials

Polo Ralph Lauren's revenues topped $4.98 billion in fiscal 2010 (ended April 3, 2010).^[1] In response to the poor economic conditions in the United States and European economies, RL has cut costs and inventories in order to prevent markdowns that would only decrease its net profits.

FY 2010 Performance (ended April 3, 2010)

Due to remnants of the 2008 Financial Crisis, Ralph Lauren had a sluggish start to fiscal 2010 but steadily improved performance throughout the fiscal year. In the Holiday Season-driven fourth quarter, the retailer posted a 157% diluted EPS improvement from Q4 fiscal 2009, which drove the annual diluted EPS to improve by 18% compared to fiscal 2009.^[3] Ralph Lauren had slightly weaker net sales in fiscal 2010 ($4.795 billion) than fiscal 2009 ($4.823 billion), but was able to have stronger net income in fiscal 2010 ($479.5 million) than fiscal 2009 ($406.0 million).^[3] RL was able to improve profitability by cutting costs and increasing its European presence.^[4] In addition, RL strengthened its fashion accessories business, as it opened stores and created product lines in handbags, watches, and footwear.^[5] Quarterly highlights are shown below.

• Ralph Lauren reported Q2 2010 earnings of $1.75 cents per share, which outperformed analyst estimates of $1.32 cents per share.^[4]
• Same store sales dropped 6% in Q2, which was an improvement over the two previous quarters, when they dropped by 13.9% and 9%.^[4]
• RL had net sales of $1.2 billion in Q3, up 6% from Q3 fiscal 2009.^[5]
• RL had net income of $111 million in Q3 ($1.10 EPS), compared to $105 million ($1.05 EPS) in Q3 FY 2009.^[5]

• In Q4, Ralph Lauren posted $1.29 billion in net sales -- a 9% increase compared to Q4 fiscal 2009.^[3] The increase was driven by strong Holiday Season retail performance, as RL had $554.3 million in retail sales -- a 31.4% increase compared to retail sales in Q4 fiscal 2009.^[3]

• Ralph Lauren projects a low double-digit increase in revenue for fiscal 2011, as well as a high single digit increase in comparable store sales for Q1 fiscal 2011.^[3]

FY 2011 Q1 Performance (ended August 4, 2010)

RL reported that its first quarter revenues 13% to $1.2 billion. Its net income increased 57% from $77 million of last year's Q1 to $121 million. Operating income also rose 49% to $174 million. This favorable performance is due to double digit growth in wholesale sales (11% increase from the same period last year) and retail sales (16% increase) as well as increased profitability in channels of distribution. During this period, RL also opened 8 and closed 5 directly operated freestanding stores.^[6]

FY 2011 Q2 Performance (ended November 10, 2010)

RL reported that its second quarter revenues grew 11% to $1.5 billion compared to the same period a year ago. Its net income also increased 15% to $205 million while operating income rose 25% to $307 million. Net revenues increased 11% to $1.5 billion due to higher global wholesale and retail sales. During this period, it opened two flagship stores, introduced a new line of Lauren handbags, and launched its first international digital flagship in the UK. For FY2011 Q3, RL expects revenue to increase by a high teens percentage rate.^[7]

FY 2011 Q3 Performance (ended January 31, 2011)

RL reported net income for the quarter increased 51% to $168 million compared to Q3 of FY2010. This resulted in $1.72 earnings per diluted share which beat analysts’ estimates of $1.28 per share.^[8]Third quarter revenues also grew 24% to $1.5 billion while comparable store sales increased by 15%. Wholesale sales increased 21% while retail sales increased by 29% compared to the same period a year ago. The Board announced an increase in the regular quarterly cash dividend to $0.20 per share from $0.10 per share. The company also authorized a $250 million stock repurchase program, reflecting its confidence in the company’s future prospects.^[9]

Business Segments

Ralph Lauren's operations fall under three primary categories: Wholesale, Retail, and Licensing.

Like other retailers, Ralph Lauren experienced e-commerce growth in fiscal 2010.^[3]

Wholesale (50.9% of FY 2010 Net Sales)

Wholesale makes up the largest portion of Polo Ralph Lauren's revenues. RL has strong relations with several department stores allowing the company to indirectly target a wide range of customers. Its collections are avaiable at 10,800 locations worldwide. Wholesale sales decreased 7.9% in FY10 to $2.5 billion.^[10] As Polo repurchases its licensed brands, a large portion of these sales are shifted to wholesale. One key area of growth in Wholesale could be the development of private labels with department stores, like the American Living brand Polo has launched in partnership with J.C. Penney (JCP). ^[3]

Retail (45.5% of FY 2010 Net Sales)

Ralph Lauren's retail stores focus on showcasing the "World of Ralph Lauren" by offering a wide selection of luxury products to customers. RL operates 631 freestanding retail and concession stores worldwide. The retail presence serves as a platform for Ralph Lauren to launch new lines and maintain brand strength. The retail segment accounted for 45.5% of RL's total revenue in FY10 as retail sales grew to $2.2 billion. Ralph Lauren's retail segment operates through the chain of 326 retail and factory outlet stores, as well as RL's online stores. In fiscal 2010, same store sales for the retail segment increased 1%.^[11], a key signal of strong growth as same store sales figures exclude sales from new store locations and are more reflective of true organic sales growth. From FY 2009 to FY 2010, retail net sales increased 9.1%.^[12]

Licensing (3.4% of FY 2010 Net Sales)

Many fashion designers license their products to third parties who independently produce and sell on a large scale while repaying the designer through royalties. Designers use licensing in order to achieve higher growth in the earlier phases of their business. While licensing provides the possibility of larger scales, it also reduces the control designers enjoy over the quality standards of their brand name.

Licensing once represented one of the largest revenue sources for Ralph Lauren, but it has moved away from this area of late by re-purchasing several of its licensed products. This move away from licensing reflects an attempt by RL to take greater control over its operations and brands. From fiscal 2009 to fiscal 2010, Licensing net sales decreased 6%.^[3]

Brands

Ralph Lauren's brands, in order from most luxurious to least, are as follows:

• Ralph Lauren Collection (womenswear only)
• Ralph Lauren Purple Label (menswear only)
• Ralph Lauren Blue Label (womenswear only)
• Ralph Lauren Black Label
• Polo Ralph Lauren
• Lauren Ralph Lauren
• Chaps Ralph Lauren

These brands are sold through retailers such as Saks (SKS), Macy's Inc. (M) and Kohl's (KSS), as well as through RL's own channels such as free-standing stores and online. In addition to the above Ralph Lauren also owns a number of niche lines such as the sports-influenced RLX and Ralph Lauren Golf, Rugby, Double RL and Club Monaco. Rugby and Club Monaco have their own stores. RL has also made an entry into home furnishings with its Ralph Lauren Home and Lauren Home lines.^[13]

American Living

As a part of Ralph Lauren's expansion plans, Polo Ralph Lauren's American Living line for J.C Penney debuted in 600 stores in February 2008 with plans to expand to all 1,048 J.C. Penney stores. With 50 merchandise categories ranging from apparel to home furnishings and a broad influence, the brand potentially allows Ralph Lauren to target a large demographic seeking high quality merchandise at lower prices. The private label partnership represents a significant opportunity for growth in the Wholesale segment for RL, as it could enter more partnerships with new brands with J.C. Penney (JCP) or other department stores.^[14] df

Trends and Forces

Department Store Consolidation and Private Labels

In recent years a wave of consolidation amongst department store chains has resulted in the emergence of a small number of major players like Kohl's (KSS), Macy's Inc. (M), J.C. Penney (JCP) and Nordstrom (JWN). These giant chains benefit from greater purchasing power and the ability to eliminate redundant physical outlets. As a result these chains hold greater sway in negotiating lower prices from wholesalers such as Ralph Lauren and are able to cut down on unnecessary expenditure. Unfortunately, this translates into lower wholesale demand and lower margins for Ralph Lauren.

Department stores have begun to compete with established brands by releasing its own private label brands. The design and manufacture of private label brands are overseen by the department store itself. Thus RL has a large amount of control over what it wants to make and how much. In addition, a department store usually makes more profit per unit of private label merchandise sold as opposed to branded merchandise from a third party.^[15] The increasing popularity of private label brands-- 19% of Macy's 2009 sales came from private brands^[16]--means they will compete for floor space with other merchandise. Ralph Lauren has attempted to solve the issue of private brands through its American Living and Chaps brands, in that RL designs the merchandise but everything else is up to the particular department store that made an agreement with RL. Thereby, Ralph Lauren capitalizes on the increasing popularity of private label brands by cooperating with department stores in the production of new exclusive product lines.

International Status Exposes Company to Exchange Rate Risk

Ralph Lauren sells its goods throughout the world. Therefore changes in exchange rates will affect prices as well as foot traffic in stores where Ralph Lauren goods are sold. In Fiscal 2009, exchange rate fluctuations led to a gain of $1.6 million.^[2] In fiscal 2010, those fluctuations led to a loss of $40 million. ^[17] In addition, during the fourth quarter of Fiscal 2009 comp store sales were down 29.3% at Ralph Lauren stores, 8% at factory stores and 20.8% at Club Monaco stores.^[18] These decreases in sales were attributed in part to lower amounts of tourist traffic brought about by the strength of the U.S. Dollar. As the dollar strengthens, the purchasing power of foreign currency decreases. Conversely, if the dollar weakens the purchasing power of foreign currency increases. Though having stores throughout the world exposes RL to multiple different markets, it also exposes it to the whims of changing exchange rates.

Ralph Lauren Intends to Capitalize on Developing Economic Strength in Southeast Asia

Asia is experiencing the growth of a new affluent class. This class has demonstrated an appetite for luxury goods. Companies such as Coach (COH) and LVMH Moet Hennessy L.V. (LVMUY) have already started plans to expand into Asia in order to best access this new market. Ralph Lauren has decided to follow suit by deciding to take direct control of its retail and distribution in Asia, specifically China, Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, Taiwan and Thailand. Originally distribution was handled by Dickson Concepts International, which sold Ralph Lauren products through 140 outlets in southeast Asia.^[19] However, RL has decided to let the license expire on December 31, 2009 in order to have more control over its products and branding in Asia. Given RL's track record of brand-building, this move can result in large profits for Ralph Lauren, especially in a time when North American sales have slumped due to the recession. According to its 2010 annual report, RL currently operates 281 locations in Asia and began to see revenue contributions from those locations with more asian expansion set to come in 2011. ^[20]

Increases in Commodity Prices Will Raise Clothing Retailer Prices

In 2010, cotton consumption exceeded cotton production for the fifth year in the row, making cotton prices increase by 80.5% from last year.^{[21] [22]} In 2009, natural disasters also severely damaged crops in many large cotton producer countries, such as China, India, and Pakistan. This led to decreases in cotton exports from these countries and increases in cotton imports as these countries sought to supplement their supply of cotton. ^[23][24] With limited cotton supplies and rising prices, retailers will either have to absorb these higher material costs, restructure the composition of their clothing to have less cotton, or pass these higher costs to its consumers. Higher clothing prices or lower quality clothing could discourage consumer spending, resulting in decreased net sales. However, adult or teen clothing retailers may not be too adversely affected as their clothing (which is usually 30-40% cotton based) has more flexibility in their composition and thus, costs.

In addition, raising commodity prices in other areas will also raise costs for retailers. The price of shipping a 40-foot dry container from China to the US has increased by 90% since 2009. Lumber and coal prices increased 36.3% and 23.7% from last year, respectively, while oil prices increased by 40% in early 2010 but has now decreased back to a steady single digit increase for the year.^[21] While premium price and established brands may be able to pass their higher costs to their consumers, value based companies may not fare as well and may suffer from lower profit margins.^[21]

Competition

As a result of Ralph Lauren's wide range of brands, it faces competition in every price point from discount to luxury.

Information on Ralph Lauren's upper tier competitors (such as Giorgio Armani and Zegna) is difficult to obtain due to the fact that many of them are privately-held companies. Of the publicly-owned firms, three of Ralph Lauren's close competitors are Abercrombie & Fitch Company (ANF), Nautica and J. Crew Group (JCG):

• J. Crew Group (JCG) is a producer and retailer of men's, women's and children's apparel and accessories. It's product assortment is traditional and mid-ranged in terms of pricing. However, it has been making an entry into the high-end market through collaborations with luxury brands such as Mackintosh and Globetrotter. J. Crew is a smaller company than Ralph Lauren, both in terms of sales and number of stores. In addition, J. Crew merchandise is sold only through its own boutiques, whereas Ralph Lauren goods are sold in retailers from Macy's Inc. (M) and Saks (SKS) in addition to its own standalone boutiques. In addition, J. Crew's merchandise stays mainly in the mid-range level, with some expensive luxury pieces. Ralph Lauren, on the other hand, runs the gamut from discount (Chaps) to luxury (Ralph Lauren Collection), increasing its target demographic.

• Abercrombie & Fitch Company (ANF) sells premium-priced apparel under four different brands: Abercrombie & Fitch, Abercrombie, Hollister and Gilly Hicks. Abercrombie and Hollister compete with Ralph Lauren's children's line. Abercrombie & Fitch competes with Rugby. ANF clothing is sold only through its 1,098 stores and its website.^[26] Ralph Lauren sells through retail stores and online as well as wholesale through department stores. Both companies have a product assortment that ranges from premium to lower-priced apparel; however Ralph Lauren's products reach the luxury market, whereas Abercrombie & Fitch is an affordable luxury retailer, which is lower-priced than luxury goods but more expensive than retailers such as Gap (GPS).

• Gap (GPS): GPS targets customers (15-25 year-old males and females). Gap has clothing lines for the 25-40 year-old age group and a strong Baby Gap clothing line for toddlers. It has a much more extensive store network throughout the U.S. and has been an established player in the market for many years.

• V.F. Group, which is a holding company whose subsidiaries run the gamut from mass brands (Lee, Wrangler, Nautica) to high-end lines (John Varvatos, Seven for All Mankind) as well as The North Face and JanSport. Nautica has the traditional, preppy styling that is most similar to the Ralph Lauren ethos, and the two have a common retailer--Macy's. Although Nautica produces apparel for men and women, the women's line is only available at the website www.nautica.com and select Nautica outlet stores due to the line's lower sales in relation to menswear. Nautica's products are priced to attract a mid-tier consumer. The line does not have a high-fashion, high-priced division like Ralph Lauren does. V.F. Corporation operates 750 for its brands throughout the world. ^[27]

{Note: RL fiscal year ends in April 2010 (considered fiscal 2010) while all other companies listed end January 2010 (considered fiscal 2009)}

^{[28] [29] [30] [31] [32]}

Footnotes

1. ↑ ^{1.0 1.1} RL 2010 Annual Report  
2. ↑ ^{2.0 2.1} RL 2010 Annual Report  
3. ↑ ^{3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7} Bloomberg, "Polo Ralph Lauren Reports Fourth Quarter and Full Year Fiscal 2010 Results," 05/19/2010
4. ↑ ^{4.0 4.1 4.2} Polo Ralph Lauren Reports 2nd Quarter Fiscal 2010 Results.
5. ↑ ^{5.0 5.1 5.2} Bloomberg, "Polo Ralph Lauren Reports Third Quarter Fiscal 2010 Results," 02/03/2010
6. ↑ http://investor.ralphlauren.com/
7. ↑ http://phx.corporate-ir.net/phoenix.zhtml?c=65933&p=irol-newsArticle&ID=1494531&highlight=
8. ↑ http://www.zacks.com/stock/news/47168/ADIDFOX/Zacks+Earnings+Preview%3A+Principal+Financial,+Polo+Ralph+Lauren,+FMC,+Sara+Lee+and+Avon+-+Press+Releases
9. ↑ http://investor.ralphlauren.com/
10. ↑ RL 2010 10k p.2
11. ↑ RL 2010 Results
12. ↑ RL 2010 Results
13. ↑ RL 2009 Annual Report pg. 5-8  
14. ↑ RL 2009 Annual Report pg. 5-8  
15. ↑ Alexandria Sage. ANALYSIS - Private label eclipsed by brands in US retail slump.
16. ↑ Macy's 2009 Annual Report
17. ↑ RL 2010 Results
18. ↑ Polo Ralph Lauren Corp. F4Q09 (Qtr End 03/28/09) Earnings Call Transcript.
19. ↑ Polo Ralph Lauren to Assume Direct Control of Distribution.
20. ↑ RL 2010 Results
21. ↑ ^{21.0 21.1 21.2} http://seekingalpha.com/article/238731-more-evidence-of-inflation-retailers-report-escalating-commodity-prices
22. ↑ Gap, Wal-Mart Clothing Costs Rise on ‘Terrifying’ Cotton Prices
23. ↑ http://www.thegovmonitor.com/world_news/asia/recession-drought-hail-reduce-cotton-acreage-in-china-12256.html
24. ↑ CNN Money - Cotton Shortage Could Inflate Clothing Prices
25. ↑ Needham Cover Initiation: Competition (11)
26. ↑ Abercrombie and Fitch Annual Report 2009
27. ↑ VF Corporation 2009 10k
28. ↑ Abercrombie and Fitch Annual Report 2009 10k
29. ↑ JCG Annual Report 2009 10k
30. ↑ Gap Annual Report 2009 10k
31. ↑ RL 2010 10k
32. ↑ VF Corporation 2009 10k