Ralph Lauren Corp. (NYSE: RL) following the company’s fiscal 2Q results. While the company’s comps are showing signs of improvement from the initial COVID-19 disruption, we expect social-distancing restrictions and economic pressure to continue for several more months, resulting in near-term challenges for RL. Although it will likely take several quarters for the company to fully recover, we expect steady earnings growth in FY21 as the economy improves and management focuses on its e-commerce channel, targeted marketing, average unit retail growth, and inventory management.
The company’s long-term strategy is to drive sustainable growth and win over a new generation of consumers by elevating the brand globally through a digital transformation, improved product assortment and presentation, and targeted expansion. Over the past two years, in connection with the company’s ‘Next Great Chapter’ plan, it has consolidated distribution points and corporate offices, underperforming stores and reduced headcount. In addition to raising average unit retail or ‘AUR,’ (i.e., the average retail price for a given item), reducing surplus inventory and fewer promotions, these actions have helped to improve margins. Ralph Lauren’s recently announced 2021 strategic realignment further builds on the strategy, beginning with accelerating the adoption of new technology, and the simplification of organizational structures, distribution points and corporate offices, and direct-to-consumer retail and wholesale. Management estimates annualized pretax savings of $180-$200 million from its initial planned actions to align its organizational structure to strategic growth priorities. Its brand portfolio is also under review and in 2022 the company’s North American Chaps menswear and womenswear business will become a fully licensed model. The company also continues to tweak its product mix and aggressively increase marketing spending in an effort to gain traction with younger consumers. Its long-term goal is to increase marketing spending to 5% of sales. It is also increasing personalization options as well as expanding its digital and social channels and its international presence – particularly in China. We believe that these efforts are gaining traction as gross margin, overall revenue, and AUR had been improving prior to the pandemic. If overall revenue stabilizes, and results improve, we would consider an upgrade.
On October 30, Ralph Lauren reported fiscal 2Q21 results. Net revenue was $1.19 billion, down 30% year-over-year on a reported basis and 31% in constant currency, and $10 million below the consensus forecast. Total comparable sales were down 28%, reflecting sequential improvement in all three regions, with a 32% decline in North America, a 29% decline in Europe, and an 11% decline in Asia. Wholesale revenues declined 37% globally in the second quarter, while bricks-and-mortar comps were down 33% as traffic declined over 40%. Comps in Ralph Lauren owned e-commerce grew 12% in 2Q, which helped to offset the declines.
Ralph Lauren has taken steps to conserve cash during the pandemic, including reducing headcount, lowering executive and board compensation, reducing inventory, negotiating rent commitments, and temporarily suspending dividends and share repurchases. It has also cut $25 million in FY21 capital spending. In 4Q20, the company drew $475 million from its revolver and entered into a new $500 million revolving credit facility. During the first quarter, RL issued $500 million in two-year notes and $450 million 10-year notes. The funds were used in part to pay down the existing $475 million credit facility. They will also be used to repay $300 million in five-year notes due August 2020.
The company reported a second-quarter adjusted operating loss of $151 million and adjusted operating margin declined 230 basis points to 12.6%. Marketing spending fell 31% as the company delayed or canceled certain activities.
The improvement resulted from favorable geographic and channel shifts as well as from AUR improvement in all regions. In the digital channel, the operating margin again improved by over 1,000 basis points, driven by higher quality of sales and SG&A leverage.
During the pandemic, RL has focused on connecting with its customers through virtual appointments and live-stream selling. Management believes that these programs have been successful and says that they have often resulted in increased customer spending. The company is also continuing targeted marketing and promotional offers.
Ralph Lauren has now suspended new store buildouts. At the end of fiscal 2Q, it had 542 stand-alone stores and 654 concessions.
EARNINGS & GROWTH ANALYSIS
Ralph Lauren has three geographic segments, all of which continue to be hurt by store closures and economic disruption due to COVID-19. As retail stores have reopened, the company has seen a gradual improvement in store traffic and comp sales. It has been working to drive traffic through expanding its retail offering to include virtual selling and appointment booking, buy online, pick up in store, curbside pickup, mobile checkout and contactless payments. It also launched its pilot Ralph Lauren virtual store experience in 2Q and is expanding personalization and social commerce programs. Despite the decline in comp sales, AUR grew 26% driven by double-digit increases in North America and Europe. Excluding pandemic-related shifts, AUR increased 20% in the second quarter. The company is also working with fewer, but more profitable, wholesale partners.
Revenue in North America (45% of 2Q revenue) declined 38% to $543 million. Comparable sales were down 32% in the retail channel, driven by a 40% decline at brick-and-mortar stores, offset in part by a 10% increase in digital commerce. Wholesale revenue fell 46% as inventory and shipments were realigned to demand. AUR in North America grew 20% as a result of reduced promotional activities and factory store ticket price increases.
In Europe (30% of 2Q revenue), revenue totaled $359 million, down 25% on a reported basis and 28% in constant currency. In the retail business, comp sales fell 29% on a 35% decline in brick-and-mortar sales on weaker traffic, partly offset by a 26% increase in e-commerce revenue. Sales benefited by 20% growth in AUR in Europe. Wholesale revenue fell 27% in constant currency, reflecting continuing efforts to right-size inventory during the pandemic.
In Asia (20% of 2Q revenue), revenue fell to $237 million, down 7% on a reported basis and 8% constant currency, reflecting continuing headwinds from the pandemic in Japan, which declined 17%, partially offset by recovery in mainland China which returned to pre-COVID growth levels of over 30%. Second-quarter results were also unfavorably impacted by the resurgence of COVID cases and weak tourism. Comp sales declined 11%, as a 32% increase in digital sales was outweighed by a 12% decline at physical stores. Management is targeting ‘Greater China’ revenue of $500 million in five years, driven by expanded distribution, digital improvement, and higher comp sales.
Due to pandemic-related uncertainty, management has not provided formal FY21 guidance. However, it expects the third quarter and full fiscal year to continue to be adversely impacted by the pandemic. It expects gross margin expansion through the second half of the year, with the last half of the year more moderate. Our estimates reflect recent result and our expectations for a gradual recovery into FY22.
FINANCIAL STRENGTH & DIVIDEND
Long-term debt was $1.6 billion, up from $693 million a year earlier, reflecting the issuance of $1.2 billion in new debt during the first. Net inventories fell 12% year-over-year.
The company has temporarily suspended stock repurchases due to the pandemic and has also suspended its dividend.
MANAGEMENT & RISKS
Patrice Louvet became the company’s new president and CEO in July 2017, replacing interim CEO Jane Nielsen.
Ralph Lauren faces risks from slower consumer spending, especially at brick-and-mortar stores, as well as from higher input, manufacturing, and labor costs. Management has limited discounts in recent quarters, but has noted that higher revenue may not fully offset cost inflation. RL also faces currency risk, as changes in exchange rates impact reported sales and earnings in international operations as well as spending by foreign tourists in the U.S. The company hedges inventory purchases to reduce the impact of currency fluctuations. It also sources about 25% of its products from China and faces risks from U.S.-China trade tensions.
Ralph Lauren, based in New York, designs, markets and distributes premium apparel, accessories, fragrances and home products. The company’s brands include Polo by Ralph Lauren, Ralph Lauren Purple Label, Ralph Lauren Collection, Black Label, Blue Label, Lauren by Ralph Lauren, RRL, RLX, Rugby, Ralph Lauren Childrenswear, Chaps (at Kohl’s), and Club Monaco.
Despite signs of improvement prior to the pandemic, we believe that RL merits a HOLD rating based on the company’s weak global sales and prospects for continued soft consumer demand in the near term.