CPRI - Ralph Lauren: An Iconic Fashion Brand Returns To Growth

2023-04-25 17:28:47 ET

Summary

• RL's strong Q3 results demonstrate the company's ability to execute and adapt to changing market conditions.
• While RL has a decent balance sheet and has generated a reasonable return on equity over the last decade, its revenue and free cash flow have declined during the period.
• Based on a comparative and discounted cash flow analysis, RL doesn't appear to be selling at a discount.

Intro

Ralph Lauren Corporation ( RL ) is a global fashion and lifestyle brand that has been around for more than 50 years. The company designs, markets, and distributes high-end apparel, accessories, and home furnishings to a diverse customer base across the world.

In the third quarter , RL posted strong results with revenue of $1.83 billion, a year-over-year increase of 0.9%. This growth was driven by a rebound in demand across all of its regions, as well as the company's ongoing efforts to expand its digital capabilities.

RL's commitment to staying ahead of fashion trends has been a key driver of the company's success in the most recent quarter, and I believe the company is well-positioned to continue delivering strong financial results in the future. In this article, we will delve into RL's recent performance, the risks associated with investing in the fashion industry, and estimate the company's intrinsic value to help intelligent investors determine whether RL stock is a sound investment opportunity in today's market.

Performance

RL's third quarter results exceeded expectations. The company's non-GAAP EPS of $3.35 were outstanding, beating estimates by $0.42, and revenue of $1.83 billion increased by 0.9% year-over-year and beat estimates by $70 million. I am encouraged by these results, and I continue to be optimistic about the company's prospects for growth in the coming years.

In North America, the company's revenue increased by 1% to $938 million. Retail sales were particularly strong, with comparable store sales up 2%. The company also saw outstanding growth in digital commerce, which increased by 9%, this was particularly encouraging, which partially offset the 1% decrease in brick-and-mortar stores. I believe that the shift towards e-commerce will continue to benefit the company in the years ahead.

In Europe, the company's revenue increased by 1% to $469 million on a reported basis and by an impressive 13% in constant currency. In Asia, revenue also increased by 1% to $386 million on a reported basis and by an even more impressive 16% in constant currency. These results are a testament to the strong demand for Ralph Lauren's products in these regions.

Investors have reason to cheer as RL's recent financial results demonstrate an encouraging turnaround for the company that has faced challenges in recent years. As a well-known name in the fashion industry for decades, RL's track record of late has been less than stellar. According to data from the last decade, RL's revenue has decreased from $6.9 Billion to $6.2 Billion. This is certainly not the kind of growth that investors like to see.

Additionally, RL's free cash flow has also decreased over the same period, from $743 million to $549 million. This decline in free cash flow is concerning and indicates that the company may be struggling to generate cash from its operations.

When it comes to profitability, RL has averaged a return on equity of 11% over the last decade, which is a decent figure. However, it's worth noting that the company had two years of negative ROE during the period. This suggests to me that RL may be struggling to effectively allocate its capital and generate a sustainable return on investment for shareholders.

Despite these challenges, RL has a decent balance sheet, with a current ratio of 2.08 and a Debt-to-Equity ratio of 1.14. This indicates that the company has a relatively low level of debt and should be able to meet its short-term financial obligations without issue.

That said, RL stock has underperformed the broader market in recent years. Over the past 5 years, the total return of the S&P 500 was an impressive 71.30%, while RL's total return was a lackluster 17.8%. This is a wide discrepancy and should be concerning for investors, most likely leaving them to wonder how RL can write the ship.

Looking ahead, the company has reiterated its full-year fiscal 2023 outlook of high-single digit net revenue growth in constant currency. I am particularly pleased to note that the adjusted operating margin is expected to be in the range of 13.5% to 14.0% in constant currency. This is a sign of the company's continued focus on efficiency and profitability.

RL's long-term focus is centered around driving growth and creating value through its three strategic pillars. These pillars include elevating and energizing its lifestyle brand, expanding its core business, and winning in key cities through its consumer ecosystem.

In particular, RL's first pillar of elevating and energizing its lifestyle brand is paying off by helping the company grow market share and AUR. RL's CEO, Patrice Louvet, emphasized this on the company's most recent earnings call stating that.

In the third quarter, we drove a diverse range of both global and localized brand activations, showcasing the Ralph Lauren lifestyle. We kicked off the quarter with our California Dreaming Fashion Show at the Huntington Library in L.A. This represented our first ever show on the West Coast, where we have historically been underdeveloped and have an opportunity to scale our presence.

However, as an investor, it is important to recognize the inherent risks associated with investing in the fashion industry. RL operates in an environment where consumer preferences can change rapidly and without warning. These changes can be influenced by a variety of factors, such as fashion trends, economic conditions, and weather.

With the rise of digital and social media, information travels quickly and can have a significant impact on the business. Failure to keep up with the latest trends can result in unsold inventory or missed opportunities, which will negatively affect the business.

Despite the risks associated with the fashion industry, RL's recent financial results have shown promising growth, particularly in digital commerce and international markets. The company's focus on its strategic pillars and its reiteration of its full-year outlook for high-single digit net revenue growth in constant currency demonstrate its commitment to driving growth and creating value. With continued focus on efficiency and profitability, there is reason for optimism about Ralph Lauren's future prospects.

Valuation

When determining the intrinsic value of RL, we will utilize a discounted cash flow ((DCF)) analysis. As many of you know, DCF is a method of valuation that estimates the intrinsic value of an investment by calculating the present value of its expected future cash flows.

To begin, we will use the average of RL's last five years of free cash flows, which amount to $549 million, as the base year for our projections. Oddly enough, the company also recorded $549 million worth of free cash flow last year.

Based on the average analyst estimates of earnings growth, we will assume a growth rate of 7.93% for the first ten years. After the first ten years, we will assume a more conservative growth rate of 2.5% in perpetuity to find the terminal value.

In addition, we will use a discount rate of 10% to reflect the long-term rate of return of the S&P 500 with dividends reinvested. Using these inputs, we can estimate the intrinsic value of RL to be $118.77. This represents a potential 2.28% return for investors, compared to the current market price. This means that at the current market price, RL is currently at fair value.

It is important to note that the accuracy of our DCF analysis is dependent on the accuracy of our inputs, such as the growth rate and discount rate. While I believe our estimates are reasonable, they are subject to change based on unforeseen factors that may impact the company's performance. For these reasons, it is essential to use multiple different valuation techniques to provide a more complete understanding of the intrinsic value of a stock, as different methods emphasize different factors.

When evaluating a potential investment, another valuation technique I like is comparing the company's current valuation to that of its industry competitors to see if it is priced favorably. I like to use a range of popular valuation ratios, such as P/E, P/S, and P/B, among others. Seeking Alpha has a wonderful " Peers " page where you can easily find a range of all these popular valuations ratios for a company like RL and see how it stacks up against its industry rivals.

A common thread among all these valuation ratios is that the lower their value, the more undervalued the company is perceived to be. By figuring the average of these ratios above, we can pinpoint the company that is most undervalued by identifying the one with the lowest score.

According to this analysis, RL appears to be priced in line with its industry peers but does carry a higher valuation than average with a score of 9.25. Capri Holdings Limited ( CPRI ), the owner of popular designer fashion brands such as Versace, Jimmy Choo, and Michael Kors, appears to be the most undervalued company in this exercise with a low score of 5.23. You may not be able to find CPRI's products on sale but its share price sure is. The final results of this valuation exercise are listed below.

1) CPRI - 5.23

2) LEVI - 7.06

3) GIL - 7.84

4) RL - 9.25

5) VFC - 9.35

6) COLM - 9.51

It is essential to note that this comparative analysis has its limitations. Aside from the PEG ratios, the rest of the ratios do not directly take into account a company's future growth prospects, which are essential in determining a company's intrinsic value. Therefore, it's best to use the results of this valuation technique in concert with the results of the DCF analysis.

In conclusion, based on our DCF analysis, RL does not appear to be a significantly undervalued investment opportunity currently that most value investors covet.

Conclusion

RL's strong results demonstrate the company's ability to execute and adapt to changing market conditions, and with ongoing investments in its lifestyle brand, its core business, and expanding in key cities through its consumer ecosystem, RL is capturing market share and increasing AUR.

While RL has a decent balance sheet and has generated a reasonable return on equity over the last decade, its revenue and free cash flow have declined, and the company has lagged behind the broader market. The fashion industry is a brutally competitive industry characterized by ever changing consumer preferences that have been ramped up by social media in recent years.

Despite these challenges, the company has seen growth across all regions recently, with digital commerce being a particular strength. I remain optimistic about RL's prospects for growth in the years ahead. The company's strong performance in the third quarter and its positive outlook for the future are a testament to the strength of its brand and its ability to adapt to changing market conditions. With that said, based on a comparative and discounted cash flow analysis, RL doesn't appear to be selling at a discount and I believe there will be better opportunities to begin building a position in the company down the road.

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