Ralph Lauren’s Distribution and Merchandising Investments Support Its Margins and Brand Strength

Senior Equity Analyst

David Swartz

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In our view, narrow-moat Ralph Lauren's restructuring over the past few years puts it on solid footing as it navigates macroeconomic challenges. In response to poor inventory control and heavy discounting in years past, Ralph Lauren has closed underperforming stores, reduced exposure to U.S. department store and off-price channels, and cut product lead times. These and other efforts have resulted in strong gross margin increases. Although sales have declined in North America from peak levels, we believe the restructuring, including new merchandise and better pricing for core products, has positioned Ralph Lauren for low-single-digit sales growth and mid-60s gross margins. Further, we forecast advertising support as a percentage of sales in the mid-single digits in the long term and anticipate its direct-to-consumer sales will rise to 76% of sales in fiscal 2033 from 63% in fiscal 2023, thereby reducing the brand’s dependence on U.S. physical retail and providing better control over pricing and positioning. We view an increasing direct-to-consumer business as essential as customer visitation is declining in many retail stores and malls.

We expect much of Ralph Lauren's growth to come from international markets. We think the brand is more of a premium brand in Europe and Asia than in North America, allowing for reduced discounting and higher average unit retail. In Europe, we anticipate store openings in underserved markets to support its existing e-commerce and attract new customers. In Asia, where Ralph Lauren trails some competitors, we expect 9% compound average annual sales growth over the next decade as stores open and e-commerce expands in mainland China. We forecast sales in Europe and Asia will rise to about 65% of total sales in fiscal 2033 from 51% in fiscal 2023. As evidence of the potential for Ralph Lauren, a comparable American brand, no-moat PVH's Tommy Hilfiger, produces about 75% of its sales outside North America.

Business Strategy & Outlook

We assign a narrow-moat rating to Ralph Lauren on the strength of its intangible brand asset. We believe Ralph Lauren is a valued partner for leading retailers as it has a presence in a very large number of categories, including apparel, footwear, accessories, home goods, fragrances, and restaurants. The firm is best known for its large selection of men's and women's apparel that ranges from mass-market product to high-end, luxury fashion. While Ralph Lauren's brands are best-known in North America (47% of fiscal 2023 sales), it owns global brands that produce more than $1 billion in annual revenue in both Europe and Asia. Since fiscal 2016, Ralph Lauren has intentionally limited distribution and reduced stock-keeping units to support the brand. These actions have led to a contraction in sales from peak levels in North America. Still, as evidence of its competitive edge, Ralph Lauren's annual adjusted returns on invested capital (goodwill included) have averaged 13% over the past five years despite adverse impact from the pandemic. Moreover, we forecast its adjusted ROICs including goodwill to average 22% over the next decade, well above our estimated weighted average cost of capital for the company of 10%.

We think the strength of the Ralph Lauren brand has allowed it to grow into one of the largest individual upscale fashion companies. Men's apparel, its primary category, is very competitive and has limited product differentiation. However, we believe Ralph Lauren, with more than $6 billion in annual revenue, has created a brand-based competitive edge over the past 50 years. The company's products are sold through multiple channels, including wholesale customers' physical stores and e-commerce, company-owned full-price and outlet stores, concession-based shop-within-shops, and directly operated e-commerce. Its retail business, which generated 63% of fiscal 2023 revenue, includes nearly 600 company-operated stores worldwide and more than 700 concession shops (mostly in Asia). Ralph Lauren has been expanding its direct-to-consumer business to improve its control over pricing, inventory, and marketing. We forecast the firm's retail business will reach 76% of sales in fiscal 2033. Ralph Lauren's wholesale business produced 35% of fiscal 2023 revenue and is composed of more than 9,000 doors. We believe Ralph Lauren achieves sizable distribution due to the popularity of its brands and the high markups available on many products. We think, though, that a greater emphasis on its direct-to-consumer business is important for the competitive position of its brand as department stores and other retailers have become too reliant on discounting. We view Ralph Lauren as one of a limited number of brands that retains an image as high-end fashion despite offering products at many price points. We think discounting, while adding to sales volume, hurts its brand in the long run. We believe Ralph Lauren can manage its brand better than third-party retailers and, therefore, we view its direct-to-consumer business as an important part of its economic moat. 

We think Ralph Lauren's narrow moat is reflected in its strong gross margins. The company achieved an average annual gross margin of 63% over the past five years due, in part, to a significant restructuring that has included cost-cutting, a greater than 30% reduction in stock-keeping units, store closures, and limitations on wholesale distribution. While these efforts reduced revenue to $6.4 billion in fiscal 2023 from $7.6 billion in fiscal 2015, they also contributed to improving gross margins. By reducing bloated inventories, Ralph Lauren has reduced discounting and improved average unit retail prices. Also, the firm has culled lower-margin product from its supply chain and eliminated smaller brands (such as its former jeanswear brand Denim & Supply, Club Monaco, and its former high-end fashion brand Ralph Lauren Black Label). Ralph Lauren has reported its highest gross margins as a public company over the past few fiscal years due to product mix (elimination of lower-margin merchandise), geographic mix, production efficiencies, price increases, and less dependence on wholesale sales. Between fiscal 2015 and fiscal 2023, Ralph Lauren's wholesale revenue as a percentage of total revenue declined to 35% from 46%. We think the increased importance of direct-to-consumer sales allowed the firm better control of pricing and its brand. In the long term, we forecast the company will hold its gross margins around 65% as it achieves premium pricing on its core products. While competition remains fierce, the company's investments to drive enhanced efficiency and eliminate some low-margin channels should support its narrow economic moat.

We think recent investments in advertising have also improved the competitive position of Ralph Lauren’s brands. The company has committed to an increase in consumer-facing advertising. Through internal surveys and sales results, the firm determined that three of its brands (Ralph Lauren, Polo Ralph Lauren, and Lauren Ralph Lauren) constitute most of its brand value. It also concluded that it had underinvested in these brands. In response, it spent $438 million (6.8% of sales) on marketing and advertising in fiscal 2023, about double the $220 million (3.3% of sales) spent six years earlier. We think Ralph Lauren had underinvested in its brands as compared with rivals. While the company has traditionally relied on print advertising, much of its additional marketing spending is going into online events and social media. Key marketing initiatives also include new video displays in stores and remodeled selling spaces. We believe these efforts are paying off and that Ralph Lauren has been able to reduce unnecessary expenses to fund greater marketing. As our moat rating is based on its intangible brand asset, we view marketing spending as beneficial to its market position.

The high prices of Polo Ralph Lauren shirts (particularly for men) provide support for our narrow-moat rating. Ralph Lauren operates multiple brands at all price points, from high-end menswear brands like Ralph Lauren Purple Label (available at luxury fashion stores like Saks Fifth Avenue) to low-priced, mass-market brands like Chaps (now being licensed). Polo Ralph Lauren, the firm's first and most visible brand, is best known for its men's shirts. Polo shirts are popular as everyday sportswear but also hold a special place in the hip-hop subculture. A few years ago, excess inventory of Polo shirts led some retailers to cut prices to below wholesale prices. We believe, though, that Ralph Lauren has cleaned up the inventory of Polo shirts enough that their prices have firmed in both full- and off-price channels. We estimate Polo shirts are sold to wholesale customers such as Macy's and Dillard's at prices around $35-$40 per unit, well above the likely manufacturing cost of less than $10. Ralph Lauren can justify these markups because Polo shirts sell in high volume and at high prices. At a manufacturers' suggested retail price of $85, Polo shirts are highly profitable for retailers. We have observed that retailers are selling many Polo shirts at this price. Even when discounted, many Polo shirts sell for $60, allowing for a strong profit margin for the retailer and supporting wholesale pricing. We think the turnaround in the Polo shirt market indicates that the Ralph Lauren brand remains strong. 

We think Ralph Lauren's restructuring has fortified its competitive position. A few years ago, the firm struggled with excess inventories at both third-party and company-owned stores. We think it significantly overproduced some product (such as Polo shirts) and overestimated demand for some high-end fashion product. This situation led to heavy discounting and weakening pricing power. In 2016, Ralph Lauren announced its Way Forward plan. The plan included efforts to instill greater discipline in distribution, improve sourcing, and reduce supply chain lead times. Among the changes, Ralph Lauren eliminated more than 30% of its stock-keeping units, reduced promotions, closed 25% of wholesale points of distribution and cut product lead times by at least 40%. The strategy included a renewed focus on its three core brands (Polo Ralph Lauren, Ralph Lauren, and Lauren Ralph Lauren) and core styles (like Polo shirts). We view the emphasis on core styles (which management claims sell 5 times as much as noncore product and produce about 70% of revenue) as a positive as fashion trends can change quickly, leading to discounting of unpopular product. 

Ralph Lauren has a place in American popular culture that most other brands do not. Its clothing remains highly visible on fashion magazine covers and at major events like the Academy Awards and Wimbledon. We think this visibility has a direct impact on sales. For example, one of Ralph Lauren's highest-profile sponsorships is as the supplier of uniforms worn by U.S. Olympic athletes at the opening and closing ceremonies. Unlike some competitors, Ralph Lauren himself remains heavily involved with the company that bears his name. While his continuing involvement is somewhat controversial among investors, his high profile is also beneficial as his many media mentions keep the company in front of consumers. For example, he was the subject of a flattering 2019 HBO documentary.

We believe Ralph Lauren has international appeal. The company’s apparel is available in about 70 countries. Average unit retail prices of its merchandise are notably higher in both Asia-Pacific and Europe than in North America due to product mix and less discounting. Also, Ralph Lauren customers outside North America tend to be more affluent, fashion-conscious, and younger. Large and well-established markets for the firm’s products include Japan (which accounts for about 50% of Asia-Pacific sales), the U.K., and the larger European Union countries. A few years ago, though, Ralph Lauren suffered some of the same problems of excess inventory in Asia-Pacific as it did in North America, so it implemented a similar turnaround plan, which we view as a success. It closed stores, remodeled others, and invested in e-commerce. It also reduced the number of stock-keeping units to better control inventory. Ralph Lauren has experienced improved sales in some territories, a sign that its competitive position remains solid despite overall sales declines. For example, the company realized 11% revenue growth in Asia in fiscal 2023. We think the company has strong control over its brands in the region as the vast majority (93% in fiscal 2023) of its sales are made through company-owned retail. 

We think Ralph Lauren has good potential in China, which constitutes only a mid-single-digit percentage of sales but is one of the world’s most important apparel markets. We think Ralph Lauren is the type of classic American brand that can be attractive to Chinese consumers. It has a strategy of opening small-format stores that carry less inventory and overhead costs, which we view as reasonable in a market with rapid e-commerce growth.

We also think the Ralph Lauren brand is solid in Europe (29% of fiscal 2023 sales) and that it has growth opportunities. As in Asia-Pacific, we believe Ralph Lauren is viewed as a premium brand in Europe. The company reports approximately 90% brand awareness in the largest European markets. It is especially well known in the U.K., where it has been a favorite fashion brand of British royals. Due to its premium positioning, we think Ralph Lauren has avoided some of the turmoil in Europe that has affected its North American business. It has strong e-commerce in Europe and operates flagship stores in several major cities. Retail partners of the brand in Europe include upscale stores like Harrod's in London, Le Bon Marché in Paris, and e-commerce firms Yoox, no-moat Zalando, and no-moat Asos. Still, we think its brands remain underpenetrated in places. Ralph Lauren only has about 45 full-price stores in all of Europe, far fewer than some direct competitors. While it has a good business in the U.K. (its third-largest market after the U.S. and Japan) and France, it trails competing brands like Hugo Boss, Tommy Hilfiger, and Lacoste in some major markets like Germany and Italy. We think Ralph Lauren has growth possibilities in Germany, especially, as its population exceeds that of the U.K. As in Asia-Pacific, we think it has the product to compete in European markets, and it plans to open more than 100 small-format stores in the region over time. We forecast annual growth in the low to midsingle digits over the next decade, in line with estimated market growth.

We do not believe Ralph Lauren has a moat based on any factors other than its intangible brand asset. Our view is that the company's gross margins of more than 60% are based on good pricing rather than low production costs. Further, Ralph Lauren, like most of its competitors, outsources manufacturing and has no apparent cost advantage. Finally, there is no network effect in the apparel business, and switching costs are nonexistent.

Narrow

Economic Moat

Ralph Lauren

Ralph Lauren Corp. engages in the design, marketing, and distribution of premium lifestyle products. The firm offers apparel, accessories, home furnishings, and other licensed products. It operates through the following segments: North America, Europe, and Asia. The North America segment consists of sales of Ralph Lauren branded apparel, accessories, home furnishings, and related products made through the Company's wholesale and retail businesses in the U.S. and Canada, excluding Club Monaco. The Europe segment caters to sales of Ralph Lauren branded apparel, accessories, home furnishings, and related products made through the Company's wholesale and retail businesses in Europe and the Middle East, excluding Club Monaco. The Asia segment covers the sales of Ralph Lauren branded apparel, accessories, home furnishings, and related products made through the Company's wholesale and retail businesses in Asia, Australia, and New Zealand. The company was founded by Ralph Lauren in 1967 and is headquartered in New York, NY.

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Earnings data Q4 2024

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Confidence in pricing power and brand desirability driving strategic decisions.

Ralph Lauren beats Q1 expectations, eyes China growth opportunities

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Ralph Lauren Corp. engages in the design, marketing, and distribution of luxury lifestyle products, including apparel, footwear and accessories, home, fragrances, and hospitality categories. The firm offers products under the brands of Ralph Lauren, Ralph Lauren Collection, Ralph Lauren Purple Label, Polo Ralph Lauren, Double RL, Lauren Ralph Lauren, Polo Ralph Lauren Children, and Chaps. It operates through the following segments: North America, Europe, and Asia. The North America segment offers Ralph Lauren branded apparel, accessories, home furnishings, and related products made through the retail and wholesale businesses in the U.S. and Canada. The Europe segment includes Ralph Lauren branded products made through the retail and wholesale businesses in Europe and emerging markets. The Asia segment consists of Ralph Lauren branded products made through the retail and wholesale businesses in Asia, Australia, and New Zealand. The company was founded by Ralph Lauren in 1967 and is headquartered in New York, NY.

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