Ralph Lauren Stock’s Defenses

I have long been interested in the history of Ralph Lauren stock, which has defied the typical short-lifespan of fashion retailers to become an actual compounder for its investors. Almost twenty years ago, the stock could have been purchased for $18 per share. Now it trades above $100 per share, and almost $18 per share in dividends have been paid out along the way. Its eighteen-year compounding rate has been 11.1%, counting dividends but not assuming reinvestment.

It’s not the type of company that I take seriously as an investment. This summer alone, the Wall Street Journal has reported on the bankruptcy of Barney’s and (soon) Forever 21, and that’s about what you’d expect from the fashion industry. The amount of space required to sell clothing is enormous and thus creates a high fixed-cost rental expense, and changing fashion tastes make it unlikely that any company will be around and profitable a decade from now.

From what I can tell, the company has four lines of defense that separates it from many of its competitors:

Number One. Ralph Lauren relies heavily on licensing. If some other store wants to sell a Ralph Lauren shirt, it can do so in exchange for paying Ralph Lauren a fee for the rights to use its intellectual property. This essentially functions as a source of ongoing passive income, or at least, profit that does not require an off-setting, commensurate expense of production.

Number Two. On the other hand, Ralph Lauren has several wholesale subsidiaries that provide clothing materials (ranging from low-end to high-end) to other retail companies. This insulates the firm from the whims of the popularity of the Polo brand in a given area because it is just profiting at an early point in the supply line.

Number Three. It earns about 15% of its overall revenue from the sale of fragrances. Although Ralph Lauren does not disclose the net profit margins on the sale of its fragrances (at least in recent annual reports), some analysts estimate that the profit margin is somewhere between 70% and 90%. Whenever someone buys a Ralph Lauren-owned cologne or perfume, it’s almost entirely profit for Ralph Lauren’s shareholders.

Number Four. The company maintains a strong balance sheet with $2 billion in cash and $900 in debt. Of the 21 largest participants in the fashion retail sector, only three had more cash than debt on its balance sheet. 

I am so adverse to the fashion retail sector (I suppose unless you consider Nike a member of that sector) that I would not consider Ralph Lauren a candidate for investment. Maybe during a crisis if it were trading at like 3x earnings like Aflac did during the financial crisis, the knowledge of its cash-rich balance sheet and multi-faceted revenue streams could make it worth a look. I don’t disfavor the company because of anything specific to it, but rather, the fashion retail sector has only compounded wealth at 4.5% since 1972 according to Credit Suisse (barely above 3.4% inflation since that time) so I cannot get over the inherent limitations of the industry. But given those limitations, it appears that Ralph Lauren has managed it as best as can be done. 

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