Although the broader market sold off yet again August 10, Ralph Lauren (RL) was a stand-out performer, with shares rising nearly 5% on a very impressive quarter.
As with literally every company in the clothing business, gross margins fell due to rising fuel and cotton costs. However, even with a 120 basis point drop in gross margins, RL achieved outstanding profitability growth, with diluted EPS up 57% on a 32% increase in revenue. We think the quarter’s same store sales growth (19%) was even more indicative of the company’s performance. Clearly consumers are going to this high-priced boutique stores and seeking out full-priced Ralph Lauren merchandise that is far more prone to sales at Nordstrom (JWN) or Macy’s (M).
We think this best represents a growing trend in retail: consumers trading up. Not from JC Penney (JCP) to Nordstrom (same store sales down over 6%) though, but rather Nordstrom to Saks (July same store sales up 15.6%) and Ralph Lauren. Given recent events, the rest of the year looks slightly more uncertain, but we wouldn’t be shocked to see the luxury trade-up continue. However, at $125, we think shares look a little rich, and would be more fairly valued in the $100 per share area.
Though the revenue growth was not quite as impressive, Macy’s (M) also reported an excellent quarter. Sales were up over 7% for the quarter, and the company guided same store sales for the second half of the year to be between 4-4.5%. This news is excellent, given the recent perceived economic slow-down. Management also guided their earnings range up about 20 cents to the range of $2.60 to $2.65 per share (was $2.40 to $2.45).
With profitability advancing considerably, it is clear Macy’s increased emphasis on diverse regional offerings is really resonating with consumers. A more decentralized purchasing hierarchy allows Macy’s to take advantage of differences in style and taste between regions to achieve higher average selling prices.
On a discounted cash flow basis, we think Macy’s shares look undervalued. However, given the market’s sentiment against department stores and the relatively attractiveness of the company versus our existing longs, we remain on the sidelines for now.