Will Ralph Lauren's Expansion Plans Hold Off Fashion Rivals?

Although the retailer posted better results than expected, net income took a hit despite higher sales. Will costs related to Ralph Lauren's expansion plans reap rewards in the long run?

Aug 6, 2014 at 4:40PM

Rl Ralph Lauren Pic
Ralph Lauren. Source: Ralph Lauren Corp.

Ralph Lauren's success as a fashion icon started from modest roots, with a simple line of men's ties that eventually led to a larger boutique, and the beginning of the now world-famous Polo symbol. During nearly half a century, Ralph Lauren Corp. (NYSE:RL) has grown dramatically, and the company sees the potential for even further growth in the future. Yet with competition becoming fiercer in the luxury end of the apparel and accessories industry, investors wonder whether Ralph Lauren's plans for global expansion are too ambitious for the current market environment.

Ralph Lauren reported its fiscal first-quarter results this morning, and investors got a mixed picture of the company's short-term success. From a longer-term perspective, however, the more important question is whether investing in the future of the business is worth the short-term hit to earnings that stemmed from higher expenses related to Ralph Lauren's expansion plans.

What Ralph Lauren said about the quarter
On the whole, Ralph Lauren's results during the past three months were fairly respectable. Overall revenue climbed 3%, with a 3% gain in comparable-store sales from its retail locations benefiting from favorable currency impacts during the quarter. Sales from Ralph Lauren's wholesale segment didn't perform as well, falling 4% from the year-ago quarter; but one-time items last year were largely responsible for the decline in the just-reported quarter's segment results.

Source: Ralph Lauren Corp.

On the earnings front, though, Ralph Lauren wasn't able to give investors the same encouraging growth figures. Despite gains in gross margins, operating expenses soared 10%, with business expansion and investment in strategic growth efforts making up the bulk of the higher costs. As a result, operating margins plunged, and that resulted in a 10% hit to net income compared to the year-ago quarter.

Why investors aren't panicking
Even though Ralph Lauren's bottom-line results weren't impressive in absolute terms, they were still better than many had feared. Most investors were expecting earnings per share to come in $0.05 below what Ralph Lauren ended up reporting. That was enough to reassure shareholders that the retailer is working hard to minimize the impact of its efforts on near-term results, even though Ralph Lauren said that net revenue would only rise by 4% to 6% in the current quarter. By the end of the day, Ralph Lauren stock had overcome initial losses of almost 3% to post modest gains.

Moreover, Ralph Lauren's guidance for the remainder of the fiscal year stayed solid, with the company still expecting a 6% to 8% rise in overall revenue. Ongoing weakness in operating margins will persist, though, as a result of ongoing above-average expenses for global expansion, as well as advertising and marketing; so Ralph Lauren could suffer earnings weakness throughout the fiscal year as its efforts progress.

Rl Wikimedia Tonythetiger
Source: Wikimedia Commons, courtesy TonyTheTiger.

What's next for Ralph Lauren?
Ralph Lauren's expansion will move on multiple fronts. The company said that the launch of its Polo for Women concept would come before the end of August, as it strives to broaden the appeal of its core fashion brand. Given the strength of luxury retail compared to more mainstream retailers, expanding the Polo brand is a smart way to capture a greater portion of a population already predisposed toward Ralph Lauren's products. Moreover, with plans to open a Polo flagship store in New York City, Ralph Lauren is paying attention to its roots, and spending to maintain its core business.

At the same time, Ralph Lauren also has ambitious geographical expansion plans. The company expects to open a flagship store in the Greater China region, seeking to add to its exposure to the strong levels of high-end consumer activity in the Asia-Pacific area.

So far, Ralph Lauren has been able to stake its claim to the growing luxury market despite the emergence of Michael Kors, and rising competition within various luxury-retail niches. Expanding to maintain market share in established locations, and to build more business in new areas, are the keys to Ralph Lauren's growth. As competitors gain exposure and become savvier, however, it will become harder for Ralph Lauren to grow without taking its rivals' plans more into account.

At some point, Ralph Lauren could see global economic weakness start to affect its high-end clientele; if that happens soon, the huge sums of money spent on expansion will have seemed ill-timed. But with signs of rising strength in some parts of the world, optimists can clearly see the growth potential that Ralph Lauren has in the long run -- even if it comes at the price of a hit to short-term earnings in the process.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Michael Kors Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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