I don't know how it did it, but back in March the ubiquitous polo rider on Ralph Lauren's (NYSE:RL) clothing snagged front-row seats to Wimbledon and will soon grace the attire of all on-court officials and staff. The five-year agreement starts when Wimbledon begins next month; it's a feat that other venerable sporting brand names haven't been able to pull off for the last 126 years. It even appears there are sore losers, as Adidas-Salomon of Germany is getting its lawyers involved.
Polo's tennis coup represents the direction that Ralph Lauren is trying to go with its brand: reaching out directly to the consumer and moving further upscale. The company hopes Wimbledon athletes wearing Polo will drive customers as it grows its own store base. Indeed, it has been playing the field by reacquiring licenses to control its own brands, such as Polo Jeans Company from Jones Apparel (NYSE:JNY). This attempt turned pretty nasty, resulting in a fourth-quarter 2005 charge of $100 million for Ralph, plus the acquisition cost to its footwear license from then stand-alone Reebok, now part of Adidas.
Ralph Lauren reports sales from three primary sources: wholesale, retail, and licensing. Focusing on opening its own stores drives the retail segment, and I'm not sure what effect this will have on wholesaling longer term, or on sales to department and other specialty stores. This is an important consideration because wholesale represents just more than half of total company sales. The licensing segment will also become less strategic as Ralph Lauren moves to take control of its brand and repurchase licenses.
Fourth-quarter and year-end fiscal 2006 results reported Thursday shed some light on the transition. Wholesale growth was still strong at 6% for the quarter and 13% for the year. Retail grew at 15% and 16%, respectively, and license revenue was down about 7% for the quarter and flat for the year. For the year, overall sales increased 13% and earnings grew nearly 57%, but only 18% when accounting for the Jones Apparel litigation expense.
Overall, Ralph Lauren has solid returns on equity and capital -- 10% to 15% over the last few years. Also favorably, as of the end of April, Ralph Lauren had eliminated all of its long-term debt.
But, in similar fashion to Payless ShoeSource (NYSE:PSS), which also reported earnings this week, the business model is in flux as Ralph Lauren tries to move more upmarket and leave its brand management less exposed to outside licensees. This is doing wonders for gross margins, but brings uncertainty about whether sales growth will follow because the initiative is new and obviously has no track record. As the track record stands now for Ralph Lauren, sales have only grown 4% on average over the last five years.
The company expects 2007 earnings of $3 to $3.10 per share, or a forward P/E of 18 to 19 times based on the current stock price of $56.10. As I said regarding Payless Thursday, I don't think this level of valuation prices in enough downside. In short, Ralph Lauren is trying to become more of a retailer, and the space is crowded. I'll include what I wrote because it fits well here: There's plenty of opportunity to find a name trading at a more compelling valuation with a more consistent track record or a more stable business model with more visible growth prospects. If you don't think Ralph Lauren is the right fit for you, try American Eagle Outfitters (NASDAQ:AEOS), Bed Bath & Beyond (NASDAQ:BBBY), or Pacific Sunwear (NASDAQ:PSUN) on for size.
Pacific Sunwear and Bed Bath and Beyond are Motley Fool Stock Advisor recommendations. What else is at the top of Tom and David Gardner's list? Be our guest at the Stock Advisor website for 30 days and find out.
Fool contributor Ryan Fuhrmann is long shares of Bed Bath & Beyond but has no financial interest in any other stock mentioned (that means he's neither long nor short the shares). Feel free to email him for feedback or further discussion on this article. The Fool has a disclosure policy.
