The Long and Short
Net cash and solid margins give Ralph Lauren an ‘A’
Meredith Contente | June 3, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Ralph Lauren posted solid fiscal 2022 results with revenue up 42% and adjusted operating margin expanded 860 bp year-over-year, a feat given the company’s substantial strategic investments to support long-term growth. After struggling to grow organically before the pandemic, guidance for the upcoming year suggests organic growth of roughly 8%. Management has also resumed shareholder renumerations, keeping rewards within the confines of free cash flow. A strong net cash position and solid adjusted margin expansion helps to support the current ratings. Despite the strong performance, RL remains the widest trading credit among ‘A’ retail peers. Should the company choose to repay its upcoming debt maturity, adjusted leverage will fall below the threshold needed to revise its outlook to stable.
Exhibit 1. Single-A Retail Curve
Net Cash Position Supported by Solid Free Cash Flow Generation
RL’s strong balance sheet is underscored by the company’s net cash position (excluding leases). RL ended the most recent quarter with $962 million of net cash, which we note has been relatively consistent throughout the pandemic. RL has been able to maintain the cash position as the company remained free cash flow (FCF) positive on an annual basis, even when stores were shuttered during the pandemic. Furthermore, RL’s FCF/sales in the most recent fiscal year (ended 4/2/22) was 8.83%, up over 260 bp from the year-ago period and only 45 bp shy of the 9.28% posted in fiscal 2019 (ended 3/31/19), despite increased costs associated with supply chain bottlenecks and energy prices. Management believes that the strong balance sheet and cash position provides them with flexibility as well as a competitive advantage when balancing both strategic investments in the business and opportunistic M&A transactions. We note that free cash flow was largely used to fund shareholder rewards this year without sacrificing the strength of the balance sheet. Capital allocation priorities have not changed with management’s first priority remaining reinvesting to support its strategic initiatives.
Exhibit 2. RL FCF/Sales (2019-2022)
Negative Outlooks Should be Revised to Stable
Both Moody’s and S&P maintain a negative outlook on RL’s current A3/A- ratings. We note that these negative outlooks were put in place during the height of the pandemic, when there was uncertainty surrounding lockdowns and how quickly the consumer would rebound. In June 2020, Moody’s both downgraded RL’s rating one notch and kept the outlook negative when the company issued $1.25 billion of notes to repay the outstanding balance under the credit facility ($475 million) as well as refinance its August 2020 maturity ($300 million). The additional proceeds were used enhance the company’s already “excellent liquidity” according to agency. S&P took a slightly different approach by placing the rating on CreditWatch Negative at the very start of the pandemic then affirming the rating with a negative outlook later in 2020. The rating was left on negative outlook after the spike in COVID cases in August 2021, but the agency noted that it could revise the outlook to stable if the company were to continue to strengthen operations while maintaining a conservative financial policy. Should the company repay its upcoming debt maturity ($500 million due 6/15/22), adjusted leverage will fall below 1.5x, a parameter that S&P has explicitly stated to revise the outlook to stable.
Issuing debt during the height of the pandemic was a common theme amongst retailers to shore up liquidity, as there was no way to know how long lockdowns would last and how long stores would be closed. However, any deterioration caused by the pandemic was short-lived as most retailers, including RL, witnessed a strong rebound. At that time, RL also received covenant relief through June 2022 when it amended its credit facility. RL also suspended its dividend and share repurchases which is consistent with the company’s historical conservative financial policies. Fiscal 2022 results have demonstrated that RL was able to navigate the disruptions caused by the pandemic and subsequent supply chain issues, as sales are back to pre-pandemic levels and the company’s adjusted EBITDA margin is roughly 700 bp higher than in fiscal 2019, when it posted an EBITDA margin of 15.4%.
Fiscal 2023 Guidance Bucks the Retail Trend
RL provided strong guidance for fiscal 2023 as it expects revenues (ex fx) to increase in the high-single digit area (~8%) relative to the year-ago period. We note that its revenue guidance is above consensus estimates of approximately 5.4%. Furthermore, RL believes they can achieve an operating margin in the 14.0%-14.5% range, which compares favorably to the 13.1% posted in fiscal 2022. Gross margin is expected to increase in the 30 bp-50 bp range, which demonstrates management’s ability to manage costs while executing price increases to offset inflation. Given the luxury nature of the brands, RL is likely to have an easier time increasing prices relative to discount retailers, as their customer tends to place a greater emphasis on quality over value. As such, management noted that average unit retail (AUR) was up 15% in fiscal 2022, which was on top of the strong 26% posted the year before, driven by its strong product offering and promotional discipline.