Before I go on my rant, let me first say that I believe Polo Ralph Lauren (NYSE: RL ) remains a compelling investment opportunity. I'll even go so far as to say that it is one of only about a handful of apparel retailers that I would seriously consider as an investment. With that said, let me also add that I can already tell I am going to be screaming at this one until I am blue in the face: Polo Ralph Lauren has a winning horse in its stable, but unfortunately, management is yanking on the reins.
What I mean by this equestrian metaphor is that Polo Ralph Lauren has a great growth vehicle that remains largely untapped in retail store development. Management's decision to dilute much of the company's time, effort, and resources to build up a new, massive wholesale brand for J.C. Penney (NYSE: JCP ) , probably cost shareholders several percentage points of top- and bottom-line growth in its fiscal 2008 first quarter.
Anemic store growth
A red flag was raised this past February while tuning into the company's fiscal 2007 third quarter conference call. In that call, COO Roger Farah announced a major new initiative under way to develop a brand from scratch to be sold exclusively in ... Nordstrom (NYSE: JWN ) ? Nope. ... Macy's (NYSE: M ) ? Sorry. You read it right the first time: J.C. Penney.
We can debate whether J.C. Penney's targeted audience is a good fit for what has historically been a premium label in Ralph Lauren. But even setting this critique aside, the thing I found most problematic with this strategy is that the company's recent turnaround hinged on the performance of its reinvigorated retail expansion efforts. These efforts were effectively put to the back burner when management decided to focus its attention on a new wholesale concept -- one that is targeted at the value-end of the market at that. I thought this decision stunk in February, and after analyzing the latest call, I think it smells even worse.
The numbers that caught my attention this quarter were the retail sales. For those units open for more than a year, comps were very strong, increasing 7.6%. Those are comps figures you want to write home to your momma about. But then I looked at the retail segment's net revenue growth and saw that it was only up 9%. What's the big deal, you ask?
Well, the reason these two figures don't exactly mesh well together is that typically with a retail concept that has a small footprint like this one and with plenty of expansion opportunity ahead of it, aggressive new store growth over the past 12 months should push net sales significantly higher than comps growth. But that wasn't the case here.
I wasn't the only one who saw this as a concern. Funny enough, the very first question in the Q&A portion of the call came from a Morgan Stanley (NYSE: MS ) analyst raising the very same issue, only he asked whether the new stores were simply underperforming. To which Farah responded:
Well, the comps ... were very strong at 7.6%. I think the net store counts for the quarter is impacted by the closing of the Polo Jeans chain, [and] the closing of the remainder of the Club Monaco outlets and Caban stores. The comp number is really reflective of the business. The new stores that we opened were fine. They were offset against last year where we were beginning the closing process on some of the other concepts.
That all sounds nice, but his response didn't sit well with me and it didn't sit well with at least one other analyst, this one from Goldman Sachs (NYSE: GS ) , who later in the call asked the same question in a different way. Let me explain why Farah didn't fully address the issue raised.
The measures that Farah addressed here -- closing down older stores, which are typically underperformers -- have a way of boosting the comps growth line, but they do not speak to the growth that comes from new stores. Here, we only have to look at two numbers: at the end of this quarter, it operated a total of 296 stores across its various concepts (Ralph Lauren, Club Monaco, Polo factory, and Rugby), or just one more than it did this time last year according to an SEC filing from a year ago. Even its high-performance Ralph Lauren concepts, which saw comps explode higher by 10.4% in the first quarter, had rather anemic store growth year over year: It has 76 Ralph Lauren stores up and running today, only 6 more than it had a year ago.
If you want to know why net retail sales growth was only in the single digits, when it should've been in the high double digits, look at the number of store openings. Polo Ralph Lauren simply dropped the ball by not being aggressive enough and opening many more Ralph Lauren stores. And the most likely reason why it wasn't aggressive here is that the company has been spending an enormous amount of time and resources getting its new wholesale line ready to roll in early 2008.
Polo Ralph Lauren has decided to bank its growth strategy, at least over the immediate term, with its upstart American Living brand that is set to debut for J.C. Penney this January. Will this new launch have a significant impact on 2008 revenues? More than likely -- there was some talk in the February call that American Living could eventually turn into a billion-dollar opportunity for the company.
But this will come at the expense of what I would argue is a multibillion-dollar opportunity in high-margin Ralph Lauren retail, an opportunity that can be realized through increased store development and continued expansion of its newly restructured website.
Polo Ralph Lauren, even with this faux pas, is a growth story that investors would be remiss for ignoring. It is just not the Derby winner that it could be.
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