Investors were happy to learn that Ralph Lauren (RL 0.79%) is still targeting solid sales and earnings growth this year. Wall Street had been worried about slowing demand, supply chain challenges, and declining profitability compared to impressive results in these areas last year.
Ralph Lauren eased a few of these worries with its latest earnings update showing steady demand and a stable profit margin outlook. The stock is performing well compared to the wider market in 2022, likely because investors see the potential for a rally if consumer spending stays strong through the holiday season.
That enthusiasm should be tempered by major risks with the apparel and accessories specialist, the biggest of which is that Ralph Lauren is entering the key holiday shopping season with too much inventory.
Let's take a closer look.
As of early July, Ralph Lauren's inventory level stood at $1.2 billion, up 47% compared to the prior year. That surge compares to just a 13% increase in first-quarter sales.
Executives painted the inventory boost as a precaution aimed at securing enough merchandise for the upcoming season demand peak around the Christmas holiday. "We deliberately shift[ed] inventory receipts earlier to mitigate global supply chain disruptions," management explained in an early August press release.
That shift sets Ralph Lauren apart from larger retailers like Target, which have slowed and delayed their purchasing plans to lower the risk of holding lots of inventory. Target executives said in July that the current demand environment required these changes "to remain nimble" as demand trends shift quickly.
Ralph Lauren admits that its approach is risky. "The global operating environment remains as volatile as ever," CEO Patrice Louvet said in a press release. But executives are still making a bold bet that they have a good grasp on consumer tastes.
Will it work?
Investors have some encouraging signs suggesting Ralph Lauren won't have to follow companies like Walmart and Target in slashing prices and taking inventory write-down charges. Demand was solid through early July, after all, and the company posted surprisingly strong profitability.
Its focus on premium lifestyle products insulates it from some of the demand shifts that have hurt other retailers, and it's also notable that Ralph Lauren doesn't sell bulky home furnishings products. These niches have been hit hardest by consumer demand shifts in recent months.
Still, investors should be aware of the big risk associated with packing warehouses with merchandise today. Economic growth trends are slowing in key markets like Europe, and shoppers are shifting their spending patterns more quickly than normal. It is always a core retailing challenge to balance supply and demand, but that goal is even harder right now.
Ralph Lauren's bet could pay off handsomely for investors if consumers snap up the products it has secured for the fall and winter shopping seasons. On the other hand, the wrong prediction would lead to lower profitability and weaker earnings through the rest of fiscal 2023.
Sure, the retailer's latest results show no signs of this profit shortfall on the way. But investors won't know for several months whether Ralph Lauren was right about its customers' enduring demand for apparel and lifestyle products. That means the stock's risk profile is rising, and investors should be careful about loading up on shares.