Cutting Through the Noise in Ralph Lauren

 | Aug 08, 2013 | 8:00 AM EDT  | Comments
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Ralph Lauren (RL) was the latest to give investors a wake-up call with its 9% decline Wednesday after it turned fiscal 2014 earnings into a "back-half story." While first-quarter earnings and sales were right in line with expectations, slack second-quarter guidance implies that earnings pressure has moved into the second half of the year.

The stock had been up some 28% year to date, and investors had to draw the line somewhere. It seems that the love fest for retail -- and, yes, even for luxury -- might be hitting a brick wall.

Ralph Lauren has been one of the most consistent players in the space, so when the fourth quarter (ended March) came in a little light, investors brushed off the concerns. After all, the old blame game to the rescue -- the weather -- and it had been a pretty legitimate excuse for that particular quarter.

But Wednesday's second-quarter guidance was a different story. The company expects revenue to rise in the low single digits, following a 4% increase in the first quarter, even as the company continues to predict full-year sales growth of 4% to 7%. Yes, that means the second half had better hit the ground running like a polo pony. Investors were also disappointed by operating-margin guidance, which forecasts a decline of 300 to 350 basis points. That compares with a first-quarter decline of 160 bps, which had topped Street estimates.

Yes, we know Ralph Lauren is in investment mode this year. It's accelerating new-store openings, systems, e-commerce and integration of the Chaps brand. But all this would not bother investors if the top line were acting as an offset.

So what could put the stock back in favor? Well, it's important to point out that 20% of Ralph Lauren's business is in Europe. The company has been paring down Southern Europe wholesale accounts, and conservative purchases among European department stores generally over the past year. But there seem to be signs of life at least in the U.K. and Germany. This makes sense, as inventories are low, and if you believe the recent European purchasing managers index, things are moving in the right direction. When Europe rebounds, it will provide for a superior gross margin vs. that of North America.

Here is another important piece of the puzzle: Ralph Lauren is not an accessories company like Michael Kors (KORS). In fact, the company is just getting started in that high-margin category, and there is even potential for stand-alone accessory stores. In addition, new-concept Polo stores will be rolling out over the next few years.

So, yes, there is plenty of noise in the numbers -- but, like a good polo player, I would not watch from the sidelines too long on this one.

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