Ralph Lauren Disappoints: Buying Opportunity or Time to Sell?

Source: Ralph Lauren.

Ralph Lauren (RL -1.21%) fell by almost 2.1% on Friday as investors reacted with pessimism to the company's latest earnings report. Performance was above expectations, and also quite strong in comparison to competitors PVH Corporation (PVH 0.53%) and VF Corporation (VFC 3.43%). However, forward guidance was a big disappointment.

Is the weakness in Ralph Lauren a buying opportunity for investors or is it time to sell before things continue to worsen for the company?

Strong performance
Net sales during the quarter ended on March 29 increased by a healthy 14% to $1.9 billion versus $1.6 billion in the same quarter of the previous year, better than the $1.8 billion forecast on average by Wall Street analysts.

Retail sales grew 5% to $845 million, while consolidated comparable-store sales declined 2% due to challenging weather conditions in North America and the shift in the timing of Easter compared to 2013. The wholesale segment was materially stronger, though, with sales increasing by 24% to $983 million during the period.

Gross margins declined 310 basis points to 56.2% of revenues. But operating costs as a percentage of revenues declined during the quarter, so operating margins increased by 90 basis points to 12% of sales.

All in all, earnings per share grew by 22.6% versus the same quarter in the prior year to $1.68, a solid performance and beating analysts' estimates of $1.64 for the quarter.

Ralph Lauren's performance during the quarter was quite strong, especially considering that industry conditions have been notoriously challenging in the first quarter of 2014. When compared to competitors such as PVH and VF, Ralph Lauren is clearly outperforming its peers.

Ralph Lauren versus PVH and VF
PVH reported an increase of 25% in total sales during the quarter ended on Feb. 2 to $2.05 billion. However, most of that increase was due to $479 million in acquired sales because of the purchase of Warnaco during the period.

When it comes to its Tommy Hilfiger brand, PVH is clearly underperforming Ralph Lauren, with a year-over-year increase in sales of 1% to $902 million versus $891 million in the same quarter in 2013. Tommy Hilfiger revenues in North America were flat, while international Tommy Hilfiger sales grew by 2% during the quarter.

VF reported solid performance during the last quarter, with total sales increasing by 6.5% to $2.8 billion during the period ended in March. But the outdoor and action sports segment was the main growth driver in the period, while the jeanswear division delivered declining revenues versus the prior year.

VF announced an increase of 14% in sales of The North Face brand, Vans produced an increase of 20% in revenues, and sales of Timberland products were up by 12% during the quarter. On the other hand, sales in the jeanswear segment were down by 4% during the quarter as Wrangler brand sales fell 2% and sales of Lee products were down by 1% year over year.

Looking forward
Ralph Lauren expects sales during 2015 to increase by between 6% and 8%, while operating margins are forecast to decline by between 75 and 125 basis points versus fiscal 2014. This represents a deceleration in growth, and declining profit margins are always an important risk to watch in such a competitive industry.

However, most of this weakness is due to increased spending in areas such as global retail development, infrastructure investments, and increased advertising and marketing.

The company plans to open approximately 40 to 45 new stores in fiscal 2015, Ralph Lauren is transforming its operations from legacy systems to SAP, and the company has embarked on a three-year project to upgrade its global e-commerce operating platform.

In addition, management is planning "a substantial increase" in advertising and marketing spending during the coming year. Ralph Lauren is also increasing support for its Polo brand as the company launches women's Polo and it builds more Polo stores around the world.

Greater China is a key market where the company wants to boost brand awareness, and the luxury products segment is another area where management is planning to increase its spending in marketing and advertising.

These initiatives can be a drag on performance in the short term, but they can also position the company for growth in the years ahead if management makes the right investments and executes as expected.

Foolish takeaway
Ralph Lauren delivered strong performance during the last quarter, both in comparison to competitors PVH and VF and on a stand-alone basis. Lower-than-expected guidance was the main reason for pessimism, but this is mostly due to increased investments and initiatives to sustain growth in the long term.

Ralph Lauren is investing for the future, and it's doing so from a position of strength. If anything, recent weakness in the stock may create a buying opportunity for investors.