Why Ralph Lauren Corp Stock Looks Stretched at Current Levels

Ralph Lauren stock - Why Ralph Lauren Corp Stock Looks Stretched at Current Levels

Source: Mike Mozart via Flickr (Modified)

There has been a sharp reversal in the fortune of retail stocks recently. Over the past several years, Amazon.com, Inc. (NASDAQ:AMZN) has come in, uprooted the entire retail industry, and caused retail stocks to drop sharply. But over the past several months, investors have started to figure out that Amazon won’t eat the entire retail pie. Retailers of all shapes and sizes will still be around into the foreseeable future. Plus, robust consumer spending during holiday 2017 didn’t hurt. All told, retail stocks have been in rally mode.

One such stock that has benefited from this retail rally is Ralph Lauren Corp (NYSE:RL). RL stock is up nearly 40% over the past year. The S&P 500 is up just 12%.

There have a been a few catalysts in the mix for Ralph Lauren stock. Namely, revenue declines have moderated significantly over the past several quarters, while gross margins have inflected upward after years of compressing.

But RL stock trades at 18-times forward earnings. The entire market trades at 17-times forward earnings.

Does it really make sense for a depressed retailer to trade at an above-market average valuation?

I don’t think so. Here’s why:

Ralph Lauren Stock Is Too Rich

Over the past five years, the narrative at Ralph Lauren has been dominated by sharp drops in revenues and margins. As such, Ralph Lauren stock has fallen 36% over the past five year years, while the S&P 500 has risen 70%.

But over the past several quarters, that narrative has flipped. Revenue trends have significantly improved, and year-over-year revenue declines have moderated from  negative 12% to  negative 9% to negative 6% over the past three quarters. Meanwhile, gross margins are inflecting upward, and have been for some time. Big investments into slimming the retail footprint, emphasizing full-price sales, curtailing discounting, and optimizing distribution have been paying off. Gross margins rose 250 basis points last quarter.

As this narrative has flipped, so has the trajectory for Ralph Lauren stock. As stated earlier, it’s up 40% over the past year versus just a 12% gain for the broader market.

That is a nice run. But investors looking for continued out-sized returns from Ralph Lauren stock are perhaps too optimistic about this company’s growth prospects.

Revenues are expected to bottom this year around $6.1 billion. But there aren’t really any catalysts which point to huge revenue growth in the foreseeable future. As such, considering revenues have been in decline for several years, the most likely outcome going forward is moderate low single-digit growth from that $6.1 billion base.

Meanwhile, margins have been exploding higher — thanks largely to price investments. But those investments are expected to slow meaningfully next year, and so is the rate of margin expansion.

Thus, when it comes to Ralph Lauren, you’re looking at a company with low single digit revenue growth potential alongside moderate margin drivers. That combination leads me to believe this is a company that can grow earnings at a 5% clip over the next five years.

At that rate, that would put earnings per share in five years at $7.58 (from this year’s $5.94 expected earnings base). Ralph Lauren stock has historically traded around 17-times forward earnings. A 17-times forward multiple on $7.58 earnings in five  years implies a four-year forward price target just shy of $129. Discount that back by 10% per year, and you get to a present value of under $90.

Ralph Lauren stock currently trades just shy of $110. That means the current price reflects one of two things: 1) expectations for more than 5% earnings growth over the next 5 years, or 2) a bigger-than-average valuation over the next several years. I don’t think a company with muted revenue growth prospects and moderate margin drivers will post 5%-plus earnings growth. Nor do I think that a retail stock with 5% or less earnings growth potential will merit an above-average valuation.

Bottom Line on Ralph Lauren Stock

The time to buy Ralph Lauren stock was before the big retail rebound that took place over the past several months.

Buying at that tail-end of that rally feels like shooting behind the duck. Ralph Lauren stock is more than fully valued at current levels, and upside in a multi-year window looks limited.

As of this writing, Luke Lango was long AMZN.

Article printed from InvestorPlace Media, https://investorplace.com/2018/03/ralph-lauren-corp-rl-stock-looks-stretched-current-levels/.

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