Ralph Lauren Corp (NYSE:RL) is a global leader in design of premium lifestyle products such as apparel, accessories and fragrance collections. While this is a type of company that is suitable for long-term oriented investors, it is essential to consider some essential risks that are not so clearly described in the typical bullish sell-side reports.
Ralph Lauren Corp (NYSE:RL) has generated strong results since the last five years due to its geographical and commercial diversification. In the last earnings report, the company delivered earnings that topped expectations. However, while I was reading Ralph Lauren’s form 10K, I found three risks that investors should evaluate.
Dependance on Mr. Lauren
As it was said before Mr. Ralph Lauren was the founder of Ralph Lauren Corp (NYSE:RL). Since its creation, this company has been managed by himself. There are two important situations that I would like to point out.
Firstly, the designs and all the important strategic decisions of the company are made by him. As he said “I try to design into a world that is constantly moving, and moving me”. How long can he get ahead of this changing world? Following what is recorded in Ralph Lauren’s form 10K, there are no signs of alternative staff that can help Mr. Ralph Lauren to be continually a step forward. In other words, Ralph Lauren has not succession plans. What could happen to the company if something happens to Mr. Lauren ?
In addition, the founder plays two important roles: being the Chairman and Chief Executive Officer and secondly, what for me is most important, being the majority stockholder of the company. Since March 2012, Lauren’s family owned 73% of the voting power of outstanding common stock of the company. These fact implies a big control over the company business by Mr. Ralph Lauren, any action that requires the approval of the stockholders can be controlled at a certain point by himself.
So, do you feel comfortable investing in a company so dependent on one key person? It might be a long or medium-term risk at this moment, even so it is a point that it has to be considered.
Profit Margins could be affected by higher commodity costs
This company depends on independent third parties that manufacture most of its products. We can find in Ralph Lauren Corp (NYSE:RL)’s form 10K that over 98% of the products were produced in Asia, Europe and South America in FY12. As it is well known, this industry is subject to significant pricing pressure. In my opinion is important to remark the secular uptrend of several commodities, such as cotton, which could impact Ralph Lauren margins. This chart shows clearly that cotton’s price has been increasing:
This is just one of many examples of how reflation is affecting the commodities market. This is a chain of consequences: commodities are more expensive, so prices of raw materials are higher, which means that Ralph Lauren profit margins get squeezed. Can Ralph Lauren set higher prices for their products? I would say it is not a viable alternative. Retailers and manufacturers were already wondering if they still had certain pricing power and now they have to face the rise of commodities prices. The problem is that their products’ prices must be adjusted, however this is not an easy task. They need to understand which percentage of their products’ final price is affected by commodities prices and then, in a meticulous way, change customers’ prices so as not to affect too much their demand. Fortunately Ralph Lauren’s problem is a bit less complicated. The reason is that this company is a big retailer, so it can negotiate with its manufacturer’s and so get a bigger profit by reducing manufacturer’s margin. Moreover, Ralph Lauren Corp (NYSE:RL) have different brands for different targets of the society. This is very important because it is probable that people who buy clothes in Champs will not suffer the increase in prices as will do people who buy in Purple Label.