Wednesday, May 25, 2011

Is Ralph Lauren's Drop A Buying Opportunity?

Shares of Ralph Lauren (NYSE: RL) are down 6% in Wednesday morning trading after the upscale clothing retailer announced a 36% drop in earnings. Does the stock price drop make Ralph Lauren's shares a bargain?

Ralph Lauren fell short of analysts' earnings estimates. It fourth quarter net income fell to $73.2 million, or 74 cents a share -- five cents short of analysts surveyed by Bloomberg. Revenue was up 6.7% to $1.43 billion from a year earlier, when Ralph Lauren reported net income of $114.1 million, or $1.13 a share.

The cause of the earnings miss is higher cotton prices and higher pay for Asian workers that Ralph Lauren did not pass on in the form of higher prices to consumers. As a result, Ralph Lauren's gross margin was down 2.2 percentage points to 56.8%  -- 0.7 percentage points less than, Michael Binetti, a UBS Securities analyst had expected.

Is Binetti right that Ralph Lauren's shares are a buy? To think about that, we can look at its price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

Ralph Lauren's PEG of 1.52 makes it a little pricey. It trades at a P/E of 19.6 on earnings expected to grow 12.9% to $6.53 in 2012. If Ralph Lauren continues to suffer lower operating margins in the 1 percentage point to 1.5 percentage point range in the next year, its stock is likely to be under pressure.

But Ralph Lauren's brand strength is such that I would keep an eye on the stock's P/E relative to earnings to look for a cheaper entry point.


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