The environment for retail and apparel stocks has been toxic lately. Thanks to a combination of bad weather, fickle customers, and plain bad results, it's been the worst part of a challenged retail sector. Despite this environment, apparel icon Ralph Lauren (NYSE:RL) is performing admirably and has a bright future.
Thanks to three unique characteristics of its management team, this business may be a bargain for long-term investors. Let's take a closer look.
The pricing power of Polo
While most of us know Ralph Lauren Corp and its iconic brand well, product familiarity alone is not an investment thesis. Ralph Lauren's biggest competitive threat comes from PVH Corp (NYSE:PVH), the fast growing apparel company with signature brands like Calvin Klein and Tommy Hillfiger.
For a fair analysis of Ralph Lauren as an investment, I'll compare it against PVH, rather than the sea of dysfunctional retailers.
After all, most retail and apparel companies have been in a dangerous spiral of discounting recently. That's not the case for Ralph Lauren and PVH. But the first thing you may not know, is just how strong Ralph Lauren Corp's pricing power, and therefore profitability, is.
Basic men's polo shirts on Ralph Lauren's website start at $85, similar "classic fit" polo's from Tommy Hilfiger start at $49.50. This is not a scientific study, it's just a brief glimpse at a pricing power edge that is backed up by fundamentals.
Pricing power directly impacts gross profit, which is simply revenues minus the cost of goods sold. While both Ralph Lauren and PVH earn fatter margins than the apparel industry as a whole, Ralph Lauren's gross margin (over 58%) has been consistently higher than its peer. As the chart below shows, for every item Ralph Lauren sells, it earns an average of seven percentage points more than PVH.
Strong brands are an especially sticky competitive advantage.The preservation and growth of the Ralph Lauren brand is the biggest part of the investment thesis for Ralph Lauren Corp.; everything else is secondary. If you have a good idea of the brand's strength, you'll know how the company is doing as well.
This brand is strengthening at a time when most retailers are discounting. Interbrand listed Ralph Lauren as number eighty-eight on its list of the top 100 brands of 2013. The Ralph Lauren brand also saw its value increase 14% in 2013, as estimated by Interbrand, and its value has outpaced the apparel sector by a wide margin.
To understand Ralph Lauren "the brand," you need to understand the man. Two landmark moments of the real Ralph Lauren's history, that every investor should know, surround his humble beginnings.
Few people know Ralph Lauren's rags-to-riches story. He was a college drop-out, and during his brief stint at Brooks Brothers, most of his ideas for new fashion were rejected. He believed there was a gap in the market, for a "classic" look that was less stuffy. Lauren himself never went to Yale, he wasn't a country club member, but he longed for a heritage look that was more accessible and inclusive.
Rather than settle, he risked everything to go out on his own, and sold ties he made out of scraps to business people in the Empire State Building. His success has been built largely off of what he couldn't have, his desire to bring it to people. That entrepreneurial fire is a rare advantage that Ralph Lauren Corp. has fed off of while building one of the best aspirational lifestyle brands.
I say lifestyle brands, and not clothing, because that's what Ralph Lauren Corp. is. Fragrances, restaurants, magazines, and even automobiles, are all products that are meant to draw you in to the "world" of this passionate entrepreneur.
PVH, on the other hand, is a business that relies on brand acquisitions to grow. While sales expanded at a rate of 25% in its most recent quarter, its Warnaco acquisition has not payed off and earnings actually declined. I prefer Ralph Lauren Corp's strategy and strong singular brand message, "the world of Ralph Lauren," because I think it naturally leads to superior pricing advantages. Right now the numbers are backing that up through strong earnings growth and superior returns on capital (as illustrated below).
Needless to say, I have faith in Ralph Lauren to guide his company through a tough apparel market. Yet, at 74 years old, any investment in this company requires faith in the next wave of Ralph Lauren Corp. management.
David Lauren is "Next"
One of the biggest keys to retail success today, is direct-to-consumer sales. This is a combination of sales from company-owned stores, and online sales. Thanks to companies like Amazon, we're no longer going to department stores as much as we used to.
Through its 435 company-owned stores, Ralph Lauren Corp. has always had a unique and wonderful in-store experience; but the online segment was foreign to the founder.
Enter Ralph Lauren's son, David Lauren.
In 2000 David was hired to run the company's Internet operation. My interest in Ralph Lauren, the stock, was first born when I read about David in 2011 in this article in Fast Company magazine. It explained his industry accolades, and detailed the growth of Ralph Lauren's e-commerce operation.
In this analysis by Trefis.com, you'll see how "RL's e-commerce sales have grown at double digit rates," growing from $300 million in 2009 (estimated) to, now, nearly $800 million. While there have been some set-backs for David, including the failed Rugby brand, it's encouraging that he's helping Ralph Lauren Corp be a leader in e-commerce at a time when so many retailers are playing catch up.
Without getting too excited, I think it's a good thing that there's a second "Lauren" in Sr. Management. Check out this quote from David Lauren in the aforementioned Fast Company article, regarding his relationship with his Father:
"When I do something that is exciting and he likes it, it feels three times as good as you can imagine." He pauses before continuing. "But when an idea doesn't get responded to appropriately, it means that my dad, my best friend, and my boss didn't like my idea. It's three times the frustration."
In apparel, vision, passion, commitment, all lead to growth and preservation of a brand. For obvious reasons, investors can only hope that David Lauren sincerely means what he says and that he's successful. He now serves as Executive Vice President, Advertising, Marketing and Corporate Communication and was appointed to RL's board in 2013. I'd say David Lauren is likely as anyone to succeed his father.
Nobody will replace Ralph Lauren himself. But if you're investing in a company that relies on its brand this much, you really don't want an interloper at the helm.
Bullish on the brand
Ralph Lauren trades at twenty times earnings, I think that's a tremendous value for a business of this caliber.
Apparel is so tough for a simple reason, the products are very similar. Polo shirts (say Ralph Lauren Polo's vs. Tommy Hilfiger) could be lumped into commodities if not for one simple thing--a strong brand. Polo shirts are synonymous with Ralph Lauren's Polo, that's brand strength!
When brands fail, prices come down, and things get ugly. Now that you know a bit more about Ralph Lauren the entrepreneur, you can make your own investment decision about the brand.