On Monday, Deutsche Bank analyst Paul Trussell downgraded Macy's (M) to "sell" from "buy." Trussell said he doubted Macy's could break out of its same-store sales rut. Troubled vendors like Michael Kors (KOR) and Ralph Lauren (RL) are holding back Macy's. I agree. Ralph Lauren has a lot of problems.
This year, the apparel sector has been a disaster. Year to date, KORS is down 42%, PVH (PVH) is down 12%, and Ralph Lauren is down 27%. Retailers selling goods from these vendors have been taking it on the chin as well. For example, Dillard's (DDS) is down 16% year to date and Macy's is flat for the year.
Retailers have been hit with weak traffic due to low consumer interest in fashion, apparel deflation due to excess manufacturing capacity, market share gains from low-priced channels like "fast fashion" retailers, a lack of excitement in terms of style and the strong dollar.
Ralph Lauren just completed a tough year. Revenue grew just 2.3% in fiscal year 2015 (ended March) to $7.6 billion. But fiscal 2016 is unlikely to be much better. Revenue is expected to be up just 0.6%. Operating margins are modeled to decline between 180 and 230 basis points vs. 13.6% last year. Promotional markdowns and the effects of the strong dollar are keeping pressure on RL.
The company is in the midst of upgrading its IT infrastructure. RL is installing enterprise resource planning (ERP) software from SAP (SAP). SAP installations always cost more and take longer than anyone expects. For example, management expects its SAP rollout in Europe will take 18 to 24 months. While Ralph Lauren expects to save $100 million annually, the rollout is costing it between $70 and $100 million a year.
Management is spending heavily to transform the company into six global groups: Luxury, Polo, Denim, Lauren/Chaps, Home and Club Monaco. Structural changes include a 5% headcount reduction, and increased efficiencies by reducing the number of SKUs the company currently designs. Of 130,000 SKUs the company designs, only 10% are global. In other words, RL redesigns the same items for different regions of the world. It hopes to reduce the number of designs and increase the commonality of its products, which should lead to better economies of scale.
Because of these changes, analysts think Ralph Lauren's operating margin will bounce back to 13%, which would drive fiscal 2017 earnings to more than $7.80 per share (up from $6.94 this year).
I don't think it will be that easy, however. We have no evidence that management can drive top-line growth. The company said it could take as long as three years to make its website mobile friendly. Without an e-commerce platform that can effectively sell on tablets and phones, how will RL further drive its e-commerce business?
In addition, there's no guarantee the company's designs will be popular next year. RL doesn't have an "athleisure" offering, which is definitely hurting sales. I guess polo players don't wear yoga pants!
To me, Ralph Lauren is a "show me" stock. I have to see evidence of life at the top line and some rebound in operating margins before I take a ride on this horse.