A Top-Tier Apparel Stock Fighting Macro Trends

For consumers, Ralph Lauren (NYSE: RL  ) is synonymous with style. For investors, the name implies impressive long-term returns. However, since Ralph Lauren relies heavily on discretionary spending, its management is concerned about the current penny-pinching macroeconomic environment. And even if Ralph Lauren can endure challenging economic times, it still may not be the best investment option in its peer group.

Revenue breakdown
Ralph Lauren operates in three segments: Wholesale, Retail, and Licensing, which accounted for 45%, 52%, and 3% of its FY2013 net revenues, respectively.

  • Wholesale revenue: sales to department stores. 
  • Retail revenue: direct-to-consumer sales via retailers and e-commerce. 
  • Licensing revenue: royalties from other companies using Ralph Lauren's trademarks.

In the recent first quarter, net revenue increased 4% to $1.7 billion year over year. While Ralph Lauren saw strength in domestic wholesale and European retail, the acquisition of Chaps Menswear in April 2013 aided its revenue bump. The revenue increase was also partially offset by weakness in European wholesale markets, and overall softness in China. Ralph Lauren is looking to mend its operating strategies and cost management in order to improve in these regions.

In addition to the Chaps Menswear acquisition, Ralph Lauren carried out its plan to close 13 of its 14 Rugby locations; it'll use the freed capital for higher-growth operations. Furthermore, Ralph Lauren has discontinued sales of most products under its American Living brand. The company took these measures to reduce costs, which could ultimately boost earnings.  

Overall, Ralph Lauren is making adjustments to perform better in a tough economy. This might sound like a logical approach, but many retailers are in denial about the health of the consumer, and have made little to no such moves themselves, simply hoping that consumers will somehow strengthen without any specific catalyst. This isn't likely, and it's refreshing to see a company admit its external challenges and prepare accordingly. 

Economic concerns
Ralph Lauren is especially concerned about the United States, Europe, and Asia, because of high unemployment rates, foreign exchange losses, volatile commodity prices, and an overall lack of consumer confidence. Perhaps more concerning is that Ralph Lauren doesn't seem to be hopeful about a potential turnaround, citing reduced government spending in the United States and continued austerity in Europe. Ralph Lauren noted inconsistent consumer traffic and spending (all three regions), and that retailers have needed to run sales and cut prices to attract customers, thinning out margins and threatening earnings.

Comparing investment options
Many investors who consider Ralph Lauren also consider PVH (NYSE: PVH  ) . While Ralph Lauren and PVH (NYSE: PVH  ) have both proven to be quality long-term investments, PVH has outperformed Ralph Lauren over the long haul:

RL Chart

RL data by YCharts

While Ralph Lauren is well-known for its namesake brand, PVH offers popular brands such as Calvin Klein, Tommy Hilfiger, Van Heusen, IZOD, Bass, Arrow, and Eagle. This broad diversification allows PVH to effectively target different markets at once. It has also led PVH to consistent top- and bottom-line performances. That said, both Ralph Lauren and PVH have remained strong over the past several years, despite challenging circumstances. 

Ralph Lauren:

 Metric

2009

2010

2011

2012

2013

Revenue (in billions)

$5.02

$4.98

$5.66

$6.86

$6.95

Diluted EPS

$4.01

$4.73

$5.75

$7.13

$8.00

 PVH:

 Metric

2009

2010

2011

2012

2013

Revenue (in billions)

$2.49

$2.40

$4.64

$5.89

$6.04

Diluted EPS

$1.76

$3.08

$0.80

$4.36

$5.87

Ralph Lauren is more attractive in two areas. First, its net margin (the percentage of revenue dollars it turns into profits) is considerably higher, at 10.54% versus 4.88% for PVH. Ralph Lauren management has been more effective at keeping costs low. Second, its dividend currently yields 0.90%, versus 0.10% for PVH. Ralph Lauren should continue to outperform PVH in the dividend area thanks to its stellar balance sheet: $1.25 million cash/$271 million in long-term debt. PVH isn't as impressive: $746 million cash/$4.48 billion long-term debt. 

If you're looking for a long-term investment, they're both likely to be winners. That said, it's important to note that both stocks plummeted more than 50% during the market crash of 2008-2009. If you're concerned about the broader market's ability to remain afloat, you won't find much resiliency here.

A much easier comparison is Ralph Lauren versus Fifth & Pacific (NYSE: KATE  ) . The latter (formerly Liz Claiborne) has a market cap of $3.02 billion, making it a much smaller company than Ralph Lauren, with a market cap of $15.40 billion. Sometimes smaller companies make better investments, but that's not likely to be the case here.

While Ralph Lauren has seen stock appreciation of 112% over the past three years, Fifth & Pacific has appreciated 435%. But this stemmed from Fifth & Pacific's stock losing more than 75% of its value in 2008/2009. Therefore, it had more upside potential from the bottom. Plus, smaller-cap stocks tend to move faster (in either direction).

Fifth & Pacific offers several well-known brands, including Juicy Couture, Kate Spade New York, Jack Spade, and Lucky Brand. But unlike Ralph Lauren, Fifth & Pacific has had difficulty growing its top line and delivering profits.

Fifth & Pacific:

 

2008

2009

2010

2011

2012

Revenue (in billions)

$3.99

$3.01

$2.50

$1.52

$1.51

Diluted EPS

($10.17)

($3.26)

($2.67)

($1.35)

($0.68)

Yes, the losses are narrowing, but whether this trend is capable of moving into profitable territory and sustaining and upward move is questionable. Fifth & Pacific hasn't been able to overcome declining consumer demand, but it has managed to cut costs in order to aid the bottom line.  

Fifth & Pacific sports a net negative net margin of (3.56%), and it's trading at 60 times earnings, making it wildly expensive compared to Ralph Lauren and PVH, which trade at 17 and 16 times earnings, respectively. Fifth & Pacific also doesn't pay a dividend. While Fifth & Pacific might make a decent speculative trade, it's not likely to outperform Ralph Lauren or PVH over the long haul. 

Conclusion
As stated above, Ralph Lauren is likely to be a good long-term investment. But macroeconomic trends, combined with managements' concern about consumers' willingness to spend, lead me to believe that now isn't likely an ideal entry point. That said, keep Ralph Lauren on your watch list and consider buying in if the stock suffers in the future -- albeit only after investors have stopped selling it off.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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