Ralph Lauren Rally a Gift for Bulls Eyeing Seasonality

Ralph Lauren Corp. shares are rising as investors anticipate earnings will accelerate in 2015.

The New York-based retailer has climbed 23 percent since May 12, while the SPDR Standard & Poor’s 500 Exchange-Traded Fund has gained 8.4 percent -- see chart. The stock-price ratio is increasing from the lowest level since September 2010 as Ralph Lauren shares closed at $181.28 yesterday and the SPDR S&P 500 ETF was at $205.76.

The stock is attracting investors who are betting the company has “turned the corner” after several quarters of lackluster earnings, said Walter Todd, who oversees about $1 billion as chief investment officer of Greenwood Capital Associates LLC in Greenwood, South Carolina. His company bought shares in September because earnings estimates for fiscal 2016 “look very beatable.”

- The forward-looking consensus of analysts’ estimates for the fiscal first quarter, ending in June 2015, is an increase of 19 percent, compared with minus 7 percent and minus 4 percent in the comparable quarters the prior two years, according to data compiled by Bloomberg.

- Ralph Lauren’s stock performance and analysts’ earnings forecasts historically track each other on a relative basis -- see chart. That differential is narrowing since April -- see chart.

- As a result, Todd said the stock could further outpace the broader market if analysts continue raising their earnings estimates -- see chart.

Ralph Lauren shares are rallying after lagging behind the market by 56 percentage points between February 2012 and May 2014. This relative weakness was partly because the company trimmed sales guidance a few times in that period, said Christian Buss, an analyst based in New York with Credit Suisse. Margins also suffered as Ralph Lauren invested “aggressively” in a reorganization plan that included technology infrastructure changes, he said.

- Now, Buss is forecasting revenue growth will accelerate as the retailer ramps up store openings, and its operating margin should benefit from the new business structure, he said.

- Buss upgraded his recommendation on the stock to outperform in August after the company “provided guidance that implied margin expansion in the second half of this fiscal year,” which ends in March 2015.

- Analysts are increasingly bullish: Almost 61 percent have a buy recommendation, up from 50 percent in January.

- While the stock is expensive relative to peer retailers, its valuation is comparable to its five-year average, so it remains attractive because of “superior earnings growth potential,” Buss said.

Increasing short interest and a period of seasonal strength also could buoy the stock.

- Short interest for Ralph Lauren totaled 3.2 million shares as of Nov. 14, according to data compiled by Bloomberg. The ratio of shares traders have sold and haven’t yet bought back relative to the total available has risen close to the highest level since October 2011 -- see chart.

- On a trailing 10-year basis, Ralph Lauren has outpaced the benchmark ETF by an average of 2.8 percentage points in February and 1.4 percentage points in April -- see chart.

Investors are valuing Ralph Lauren higher as the stock has broken a relative downtrend in place since 2012, according to Jim Stellakis, founder and director of research at Technical Alpha Inc. in Greenwich, Connecticut. This pair trade -- buying Ralph Lauren and shorting the S&P 500 ETF -- recently surpassed a significant resistance level, which could be “the beginning of a new outperformance trend” as traders are “more willing to put capital in it than any time this year.”

Ralph Lauren appeals to Todd because of its global exposure and multichannel business model -- it sells clothing directly and through retailers such as Macy’s Inc. -- though other investors are taking a “wait and see approach,” he said. Some traders remain disappointed by management’s reduced revenue forecasts in the past, while the company’s overseas business could stumble amid sluggish economic growth in Europe. In addition, the rising short interest reflects skepticism about margin-expansion potential, Buss said.

While all companies are subject to periods of organizational problems, Ralph Lauren is a “very iconic brand,” so Todd and his colleagues bought it when they saw an opportunity to place a bet on a turnaround, he said.

For some traders, the “proof point” for this strategy to work will be whether margin expansion remains intact, Buss said.

As a result, the company could be an attractive “show-me story” within the retail sector coming out of the holiday season, Todd said.