With the latest annual report released for Ralph Lauren Corporation, I am able to update my analysis and views on the company. Please find below the performance ratios with the latest public data and the conclusions drawn.
The suggested peer group from Ralph Lauren are listed below and they will be used for comparison:
Burberry Group PLC, Coach Inc, Compagnie Financiere Richmont SA, The Estree Lauder Companies Inc, Hermes International, The Jones Group Inc, Kenneth Cole Productions Inc, Liz Claiborne Inc, Luxottica Group, LVMH, PVH Corp, PPR SA, Tiffancy & Co, Tod's SpA, VF Corporate, The Warnaco Group Inc.
Liquidity
The large difference between the current and quick ratio demonstrates that a large part of the RL current assets are dependent on their inventory.
To really understand their liquidity position, we must analyse the time taken to turn inventory into cash and the average period of their accounts receivable.
The cash ratio is an even more conservative measure of liquidity as it removes accounts receivable from the numerator. With a ratio of 1.25 it does show that RL have significant liquid assets to cover more than their current liabilities. However, with such a "healthy" ratio it does raise the question: could they be putting these assets to better use? Rather than retaining it on their balance sheet, they could be returning money back to shareholders or invest it in other places.
With a cash conversion cycle of 105 days, their sales process is relatively liquid. Cash is not being tied up in their inventory and accounts receivable and which gives them ample time to pay off trade payables. Due to the economic environment, RL do not want to be squeezed on the company's liquidity which could explain the large amount of cash hoarded by the company. Keep cash on its balance sheets allow RL to remain agile removing need to borrow in order to take advantage of price discounts for raw materials and expansion into new products and markets.
To really get an idea of the direction the company is heading in terms of its liquidity. We need to analyse the trends in each component of the cash conversion cycle: days inventory outstanding, days sales outstanding and days payables outstanding.
Ralph Lauren's strength lies in its liquidity. With higher current, quick and cash ratios, it demonstrates their financial stability. However, their cash conversion is average at 105 days and it explains the difference between their current and quick ratios with assets held as inventory. I believe due to their capital strength this should not be a concern.
Profitability
We must understand that the absolute values calculated are unilluminating, depending on the industry, a profit margin of 10% could be outstanding (airlines) whereas in another (software engineering) it could be abysmal. Therefore, for the best insight into a company's management of costs and growth is to compare the ratios against the rest of the industry.
The significant difference between the gross profit margin, 58.29% and operating margin, 15.15% reflects the nature of the industry. High rent in prominent locations, large staff numbers and global expansion all contribute to the high SG&A costs. There is an increasing trend in the operating expense which can be explained away by the expansion the company has financed but management must keep an eye on this figure from further eating into its profits.
At a glance, Ralph Lauren's return on assets at 12.57% is strong. Investors typically like ROA of at least 5% but there are certain industries where lower ROAs are acceptable, like banking for example. We must compare this with its peers before making further judgement on its value.
The return on equity is also strong at 18.64%. This figure can be misleading if there is a disproportionate amount of debt compared to equity. We can get a better idea of returns from the returns on capital employed ratio which takes into account the total capital investment. At 17.34%, we see that the debt which is included in this calculation has had a small effect on the returns which indicates that the borrowings of Ralph Lauren is low compared to their equity base.
Ralph Lauren's margins are average and could be improved upon, due to the brand's positioning I think it would be difficult for RL to improve on this figure. This impact rolls onto the returns ratios. The brands with the higher profit margins due to their higher product positioning boast superior returns, which is expected.
Debt
Liabilities can come under two groups on financial statements: operational and debt. Operational liabilities include accounts payable, expenses accrued, pension obligation, etc. The latter includes short-term borrowings, current portion of long-term borrowings and long-term borrowings.
Analysing the debt will give us an idea of the financial risk the shareholders face. Generally, the higher the debt, the higher chance of bankruptcy. Holding debt allows the company to be leveraged, this means any profits generated above the cost of capital will provide enhanced returns to the equity holders, but of course losses are also multiplied if the inverse is true.
With a debt ratio of 32.57%, RL is relatively unlevered. As the ratio includes operational liabilities, the true debt ratio which reflects only financing debt will be lower. In the event of bankruptcy, as the total assets cover the indebted amount and shareholders not lose everything if assets need to be liquidated to repay creditors. The debt-equity ratio, a measure of the amount of capital committed by creditors versus equity holders, is also modest at 48.30%. This tells us the majority of capital and thus returns is created by the shareholders themselves. It is strange that despite being a large company and thus can withstand leverage without facing financing difficulties, Ralph Lauren has veered away from borrowing. Using the capitalization ratio, which takes into account only permanent/long-term capital, we can confirm that RL is hardly leveraged at 6.99%. This could be a conscious effort to minimise financing cost and maximise profit margins.
Payment of interest on financing activities is vital for a company to stay alive. It is no surprised that an interest coverage ratio of 42.42 means Ralph Lauren is able to meet interest expenses with ease. They are able to service a much larger debt and it could be a positive move to raise capital in the debt markets to finance growth for higher income, despite sacrificing margins.
As RL has a low level of leverage compared to its capital base, it is no surprise that it has a cash flow to debt ratio of 323%, posing little risk of default due to its low debt and strong operating cash flow.
As alluded to in a previous section, due to the little amount of financing Ralph Lauren receives from raising debt, their ratios compare favourably against the rest of the field, apart from Richemont, Coach and Hermes with even less debt.
Operating Performance
In this section we will explore the different components of a company's operating performance, shedding light on how efficiently resources are used to increase sales and shareholder value. The fixed-asset turnover ratio measures the productivity of fixed assets like property, plant and equipment at generating revenue. The current fixed-asset turnover ratio is 8 but we will need to see the historic trend and sector average before a meaningful conclusion can be made.
Moving on from fixed assets, we can now look at how much revenue is generated per employee with the revenue/employee ratio and look at the personnel productivity. Being in a labour-intensive industry, RL must employee sales assistants for each of their stores which could explain the $275000 figure, but then again so would most other companies in the sector.
Cash Flow Indicators
Although some companies are very profitable, they can in fact be under great financial risk if the majority of profits are made on credit and have not actually received cash for the sales. These ratios will allow us to better understand the amount of cash that is generated and the buffer it provides.
The cash flow/sales ratio is 12.9%, and we can see healthy consistency over the last few years. The free cash flow/operating cash flow ratio is 69.25% which is very high and indicates a strong financial position. With no short-term debt and current portion of long-term debt in the fiscal year, the short-term debt coverage ratio would not be useful but it is obvious they would not need to worry about short-term debt obligations. The capital expenditure coverage is impressive at 3.25 and thus has abundant funds to finance necessary assets for expansion and growth. Usually, capital expenditure and operating cash flow need to be at least equal to ensure that the financial position of the company is not limiting the growth of the company. Shareholders will also be pleased that the dividend coverage ratio is also high at 11.92 and that their dividends are affordable and not in danger. In fact, the opposite is true with Ralph Lauren doubling dividends per share to $0.20 for the second year running (double originally in 2009). It is obvious for the previous calculations that the capital expenditure and cash dividends coverage will be impressive, and is at 2.55. This means RL are generating large amounts of free cash flow and is an incredibly attractive metric for investors.
As Ralph Lauren is a dividend paying company, we can also calculated the dividend payout ratio. At 11.22%, this seems like a reasonable value. RL has doubled its dividend payout twice in the last 3 years reflecting the strong earnings and delivering value back to the shareholders from its excess cash, a trend that seems sustainable or at least maintainable at its current level. At the same time, this ratio does not seem exaggerated, this is because although it is an established company, it would need to retain some earnings to finance its aggressive expansion plans into the Far East.
Investment Valuation
The EPS of the share is relatively high at $7.35 or $7.13 per diluted share. Although it is a good indicator of value, without considering the share price we cannot judge if the stock is over or underpriced. Looking at the price/book ratio, the company was trading at 3.71x the book value of $39.40. Excluding intangible assets it is 5.92x. This multiple is flawed in the fact that assets are recorded at their historical cost and also in this modern age, information assets can be undervalued. However, it is more widely used in capital-intensive or finance-related industries.
The price/cash flow ratio is 15.32x and used to evaluate the attractiveness of an investment as it is harder to manipulate the cash flow of the company. The price/earnings (P/E) ratio is $20.52 which suggests that investors are currently willing to pay $20.52 for every $1 of Ralph Lauren's earnings. This relatively high P/E ratio suggests that investors are still expecting growth from this company, which when viewed with their business strategy, is a fair view. Look at projected P/E ratios by reviewing estimated basic earnings per share and The Value Line Investment Survey's combination approach. Compare with historical 3-5 year values. Look at P/E ratio of the overall market (S&P500), industry segment and direct competitors. Looking at the growth estimates with the P/E ratio, we can get a better idea of whether this stock is over or undervalued. Analysts are estimating next year's EPS to be $7.96. From this, we can calculate the price/earnings to growth ratio (PEG). A value of over 1 suggests that the company is overvalued, as the growth for the company will not surpass the premium paid for the stock. A value of under 1 suggests the opposite and a value of exactly 1 suggests it is fairly valued. For stocks with high P/Es, this allows the investor to quantify if the price is worth the return. At 1.76 it suggests that for Ralph Lauren with a holding period of a year, this stock is overvalued. I disagree. Analysts are generally overly bearish in tougher times as seen with the estimates for Q1 2012 with many companies beating estimated EPS. However, with a two year horizon, EPS estimates currently stand at $9.26 which brings the PEG ratio down dramatically to 0.69, showing significant discount to the current P/E.
According to What Works On Wall Street (McGraw-Hill, 1998), stocks with a low price/sales ratio outperform stocks with low P/E ratios. Also because earnings can be manipulated by accountants and management, more and more investors are allocating a larger weight to the price/sales ratio. For Ralph Lauren, investors are currently paying $2.04 for every dollar of sales. With their low debt (and thus little need for further equity issuance) and steady revenue growth, assuming a constant share price I believe this ratio will definitely fall.
The fundamental driver of share prices for the investor should be the dividends that are received and historically speaking, dividend paying stocks have outperformed their counterparts. Ralph Lauren paid $0.80 in dividends per share which reflects a dividend yield of 0.5%. This is relatively low for a mature company and we saw from previous analyses that they are able to pay greater dividends. However, RL also has many growth attributes and as a growth investor, this low yield is not concerning.
Using the enterprise value (which can be seen as the price of a takeover) and EBITDA we can work out the enterprise value multiple. For Ralph Lauren, it tells the investor that it would take approximately 10.41 years for an acquirer to pay off the costs assuming constant earnings.
Low Days-Sales-Outstanding indicates that operationally, the sales cycle is efficient. In these current economic conditions it is definitely an advantage. Compared to competitors, Ralph Lauren also has a shorter Days-Inventory-Outstanding which means cash is not tied up as stock. The Days-Payables-Outstanding is less favourable. Their competitors are significantly better at deferring payment and the reasons must be investigated. Ralph Lauren is a big enough brand to push for more favourable terms from their suppliers.
Cash Flow Indicators
Although some companies are very profitable, they can in fact be under great financial risk if the majority of profits are made on credit and have not actually received cash for the sales. These ratios will allow us to better understand the amount of cash that is generated and the buffer it provides.
The cash flow/sales ratio is 12.9%, and we can see healthy consistency over the last few years. The free cash flow/operating cash flow ratio is 69.25% which is very high and indicates a strong financial position. With no short-term debt and current portion of long-term debt in the fiscal year, the short-term debt coverage ratio would not be useful but it is obvious they would not need to worry about short-term debt obligations. The capital expenditure coverage is impressive at 3.25 and thus has abundant funds to finance necessary assets for expansion and growth. Usually, capital expenditure and operating cash flow need to be at least equal to ensure that the financial position of the company is not limiting the growth of the company. Shareholders will also be pleased that the dividend coverage ratio is also high at 11.92 and that their dividends are affordable and not in danger. In fact, the opposite is true with Ralph Lauren doubling dividends per share to $0.20 for the second year running (double originally in 2009). It is obvious for the previous calculations that the capital expenditure and cash dividends coverage will be impressive, and is at 2.55. This means RL are generating large amounts of free cash flow and is an incredibly attractive metric for investors.
As Ralph Lauren is a dividend paying company, we can also calculated the dividend payout ratio. At 11.22%, this seems like a reasonable value. RL has doubled its dividend payout twice in the last 3 years reflecting the strong earnings and delivering value back to the shareholders from its excess cash, a trend that seems sustainable or at least maintainable at its current level. At the same time, this ratio does not seem exaggerated, this is because although it is an established company, it would need to retain some earnings to finance its aggressive expansion plans into the Far East.
Investment Valuation
The EPS of the share is relatively high at $7.35 or $7.13 per diluted share. Although it is a good indicator of value, without considering the share price we cannot judge if the stock is over or underpriced. Looking at the price/book ratio, the company was trading at 3.71x the book value of $39.40. Excluding intangible assets it is 5.92x. This multiple is flawed in the fact that assets are recorded at their historical cost and also in this modern age, information assets can be undervalued. However, it is more widely used in capital-intensive or finance-related industries.
The price/cash flow ratio is 15.32x and used to evaluate the attractiveness of an investment as it is harder to manipulate the cash flow of the company. The price/earnings (P/E) ratio is $20.52 which suggests that investors are currently willing to pay $20.52 for every $1 of Ralph Lauren's earnings. This relatively high P/E ratio suggests that investors are still expecting growth from this company, which when viewed with their business strategy, is a fair view. Look at projected P/E ratios by reviewing estimated basic earnings per share and The Value Line Investment Survey's combination approach. Compare with historical 3-5 year values. Look at P/E ratio of the overall market (S&P500), industry segment and direct competitors. Looking at the growth estimates with the P/E ratio, we can get a better idea of whether this stock is over or undervalued. Analysts are estimating next year's EPS to be $7.96. From this, we can calculate the price/earnings to growth ratio (PEG). A value of over 1 suggests that the company is overvalued, as the growth for the company will not surpass the premium paid for the stock. A value of under 1 suggests the opposite and a value of exactly 1 suggests it is fairly valued. For stocks with high P/Es, this allows the investor to quantify if the price is worth the return. At 1.76 it suggests that for Ralph Lauren with a holding period of a year, this stock is overvalued. I disagree. Analysts are generally overly bearish in tougher times as seen with the estimates for Q1 2012 with many companies beating estimated EPS. However, with a two year horizon, EPS estimates currently stand at $9.26 which brings the PEG ratio down dramatically to 0.69, showing significant discount to the current P/E.
According to What Works On Wall Street (McGraw-Hill, 1998), stocks with a low price/sales ratio outperform stocks with low P/E ratios. Also because earnings can be manipulated by accountants and management, more and more investors are allocating a larger weight to the price/sales ratio. For Ralph Lauren, investors are currently paying $2.04 for every dollar of sales. With their low debt (and thus little need for further equity issuance) and steady revenue growth, assuming a constant share price I believe this ratio will definitely fall.
The fundamental driver of share prices for the investor should be the dividends that are received and historically speaking, dividend paying stocks have outperformed their counterparts. Ralph Lauren paid $0.80 in dividends per share which reflects a dividend yield of 0.5%. This is relatively low for a mature company and we saw from previous analyses that they are able to pay greater dividends. However, RL also has many growth attributes and as a growth investor, this low yield is not concerning.
Using the enterprise value (which can be seen as the price of a takeover) and EBITDA we can work out the enterprise value multiple. For Ralph Lauren, it tells the investor that it would take approximately 10.41 years for an acquirer to pay off the costs assuming constant earnings.
