Ralph Lauren Capital Structure
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Pace Executive MBA Finance (MBA 716) final project on Ralph Lauren's Capital Structure. Description of project: You have been hired by Ralph Lauren Corporation (NYSE:RL) to determine the most efficient capital structure to maximize shareholder value creation. Specifically, you will: 1. Identify the optimal capital structure and the dollar benefit to shareholders of moving from RL’s actual to optimal debt ratio 2. Based on the above, recommend whether share repurchase or investment in new projects with debt is the best way to improve RL’s debt and equity mix.
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Ralph Lauren Capital Structure
- 1. Ralph Lauren Capital Structure Omair A.,William Burkey, Dilip P., and Byron R.
- 2. Executive Summary • RL should issue new debt to buy back shares: • We recommend moving the optimal cost of capital with debt ratio equal to 30% . • This will increase the value of the firm by $1.3-1.6 billion. • Corresponds to $15-$18 dollar increase in the price of the stock.
- 3. Breakdown of Ralph Lauren Global Leader in premium lifestyle products Net Revenues increased by $505 Million in FY 2014 Gross Profits increased to $4.310 Billion in FY 2014 Net income increased to $776 Million in FY 2014 Current strategy: China Accessory growth Brand awareness
- 4. Market Driven Metrics BenchmarkedAgainst Peer Groups
- 5. ROA – Ralph Lauren versus Peer Group FY 2014 ROA Comparison 0 5 10 15 20 25 30 35 PVH VFC RL NKE COH BURBY EL 1.49 12.17 13.52 15.04 31.26 15.15 14.85 ROA % (Net)
- 6. ROE – Ralph Lauren versus Peer Group FY 2014 ROE Comparison 0 10 20 30 40 50 PVH VFC RL NKE COH BURBY EL 3.79 21.66 19.9 23.08 47.13 26.99 33.88 ROE % (Net)
- 7. ROI – Ralph Lauren versus Peer Group FY 2014 ROI Comparison 0 10 20 30 40 50 60 70 7.31 22.78 28.05 35.27 69.07 31.12 35.27 PVH VFC RL NKE COH BURBY EL
- 8. Ralph Lauren ROIC and ROE The ROIC and ROE are estimated using the beginning and average value of equity, debt and cash. For 2014 : ROIC = 29% > WACC = 8.35%. ROE = 21% > RE = 9.4% RL takes good projects bringing value to the firm based on ROIC and bringing value to shareholders based on ROE.
- 9. RL P/EVersus Peer Group 0 20 40 60 80 75.26 22.55 18.1 26.07 12.44 20.36 29.19 PVH VFC RL NKE COH BURBY EL
- 10. Historical P/E for RL
- 11. Historical RL P/EVersus Peers
- 13. Revenue $6,945,000 $6,042,999 $11,419,648 $1,556,618 $1,264,935 $6,860,000 $5,890,624 $10,879,855 $1,414,398 $1,043,403 $- $2,000,000 $4,000,000 $6,000,000 $8,000,000 $10,000,000 $12,000,000 RL PVH VFC DECK KATE 2013 2012
- 14. 3.37 2.18 4.73 3.09 71.05 0 10 20 30 40 50 60 70 80 RL PVH VFC DECK KATE Price to Book
- 15. 1.83 1.8 2.33 1.73 3.5 0 0.5 1 1.5 2 2.5 3 3.5 4 RL PVH VFC DECK KATE Price to Sale
- 16. Stock Performance with Peers
- 17. Stock Performance with S&P
- 18. RL EBIT Fell During Heavy Investment
- 19. Geographic Breakdown in Revenue 64.2% 65.5% 65.8% 68.6% 95.8% 35.8% 34.5% 30.2% 31.4% 4.2% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0% 120.0% RL PVH VFC DECK KATE US and Canada International
- 20. RL Geographical Revenue Growth Breakdown
- 22. Total Debt/Equity RL and peers have low Debt/Equity 0 1 2 3 4 5 6 0.89 0.230.14 0.75 5.97 PVH VFC RL DECK KATE **Total Debt/Equity = Debt / Common Stock Equity Debt = % Current of LT Debt + LT Debt +Cap Lease Ob.
- 23. RL Compared to Peer Group and Industry 15% 30% 25% 0% 5% 10% 15% 20% 25% 30% 35% RL Peer Group Average Average** Morningstar Debt to Equity %
- 24. RL Compared to Peer Group and Industry Morning Star S & P / Moody's NKE AA- AA/A1 VF A A/A3 PVH BB BB+/Ba2 COH - - RL A A/A3
- 25. Optimal Debt Ratio What is the Optimal Debt Ratio for Ralph Lauren? Current Optimal Change D/(D+E) Ratio = 14.58% 50.00% 35.11% Beta for the Stock = 1.34 2.04 0.70 Cost of Equity = 9.50% 12.62% 3.48% Rating on Debt A3/A- After-taxcost of Debt = 2.82% 2.44% -0.21% WACC 8.53% 7.53% -0.64% Implied Growth Rate = 2.80% 2.59% 0.21% FirmValue (Perpetual Growth) = $16,024 $18,461 $2,536 Value/share (Perpetual Growth) = $154.27 $181.35 $28.59 RESULTS FROM ANALYSIS
- 26. Constraints Interest Coverage Ratio Ralph Lauren’s PreTax Interest Coverage ratio = 4.18 For large non-financial service companies with market cap > $ 5 billion > ≤ to Rating is Spread is 8.50 100000 Aaa/AAA 0.40% 6.5 8.499999 Aa2/AA 0.70% 5.5 6.499999 A1/A+ 0.85% 4.25 5.499999 A2/A 1.00% 3 4.249999 A3/A- 1.30% 2.5 2.999999 Baa2/BBB 2.00% 2.25 2.49999 Ba1/BB+ 3.00% 2 2.2499999 Ba2/BB 4.00% 1.75 1.999999 B1/B+ 5.50% 1.5 1.749999 B2/B 6.50% 1.25 1.499999 B3/B- 7.25% 0.8 1.249999 Caa/CCC 8.75% 0.65 0.799999 Ca2/CC 9.50% 0.2 0.649999 C2/C 10.50% -100000 0.199999 D2/D 12.00% Interest coverage ratio
- 27. Constraints DEBT/ EBITDA Ralph Lauren’s current DEBT/EBIDA = 5.48 Moody's Ratings for DEBT/EBITDA for Retail > < to Rating is 0 0.75 Aaa 0.75 1.5 Aa 1.5 2.5 A 2.5 3.5 Baa 3.5 4.5 Ba 4.5 6 B 6 8 Caa 8 >8 Ca
- 28. Debt to Capital Beta cost of equity After-tax cost of debt WACC Rating effective tax rate ACTUAL 15% 1.34 9.29% 2.12% 8.33% A3/A- 0.292 OPTIMAL WITH CREDIT RESTRICTION 30% 1.56 10.37% 2.12% 7.89% Aa2/AA 0.292 OPTIMAL 50% 2.04 12.78% 2.54% 7.66% A 0.292 Capital Structure
- 29. Cost of Financing at Existing Debt Ratio (Mil $) $1,336.91 Cost of Financing at Optimal Debt Ratio (Mil $) $1,267.59 Savings for one year (Mil $) $69.32 Change in Value of the firm (PV of future savings) (Mil $) $1,341.03 $1,699.65 Risk Free Rate Implied Growth Rate Growth 2.59% 3.67% New Value of the Firm (Mil $) $17,399.77 $17,758.39 Increase in Stock Price ($) $15.11 $19.16 New Stock Price ($) $169.38 $173.43 NewValue of the Firm
- 30. LongTerm Financing Cost of Capital with debt ratio equal to 30% Increase of $1.3-1.6 billion in the value of the firm $16,059 $17,399.77 $17,758.39 Actual RF Implied gr
- 31. LongTerm Financing Cost of Capital with debt ratio equal to 30% $15-$19 dollar increase in the price of the stock 154.27 169.38 173.43 140 150 160 170 180 Current RF Implied gr Stock Price
- 32. Conclusion
- 33. LongTerm Debt & Dividend Policy Share Repurchase Dividend increase Share value increase Re-invest in emerging markets LongTerm Financing LT bonds due in 2018 LT debt increase by issuing 20 – 30 year bond Low interest rates
- 34. Conclusion Achieve a Optimal 30% Debt/Equity Ratio We Recommend Ralph Lauren to Issue New Debt Repurchase Stocks, Lowering OverallCost of Capital
Editor's Notes
- -Ralph Lauren should increase debt to take advantage of low interest rates which in turn helps with their tax bracket. -RL should issuing new debt in order buyback shares. Ralph Lauren has one the lowest debt in its industry so we believe taking on more debt would not be a problem. -This would enable the company P/E ratio to go up and in turn be more attractive for investors.
- -We believe its business strategy is in the right direction in expanding to China and accessories. We believe that company will execute in the long run. In 1990 Ralph Lauren rebuilt its European business after it lost control of the brand and we believe same will happen to China. RL’s new path likely calls for success outside of its core strengths: Retail growth, license buybacks and effective infrastructure investments have driven solid, predictable EPS growth since the mid-2000s. However, gains from those opportunities are slowing. Part of the new plan calls for growth in areas where RL has not had as much success – China and accessories.
- Omair will now be talking about Market Driven Metrics such as Return on Assets, Return on Equity, Price Earnings Ratio which has been Benchmarked against it Peers We compared RL to its peer groups to get a broader picture of the industry and how RL fits into.
- First we looked at return on assets to see how RL compares profitability wise as compared to its peer groups. This graph giv a snap shot of the industry. As you can see compared to the assets of the industry ralph lauren is slightly below average except for PV and COH which has no debt which is why the ROA is high. This may indicate ralph lauren is not effectively converting its investments into profits Ralph Lauren return on assets is slight below average of peers groups, in other words, RL is not effectively converting its investments into profit). There for your return on assets will lower.
- Definition: The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. Ralph Lauren has a below average ROE, meaning shareholders are not currently investing in Ralph Lauren. Next we looked at return on equity as you can see ralph lauren falls below the industry average indicating shareholders are not investing in theRL as much as nike, COH, and BBRY. As we will discuss in more detail in our presentation we will omplement a buy back program to increas RL, ROE to make more comparable to peers
- For this chart we calculated ROI without operating leases. The ROI for RL is 28,05 in 2014 which is below the average of its peers except for pvh and VFC Definition: A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio. The return on investment formula: ROI = (Gain from Investment – Cost of Investment) / Cost of Investment In the above formula "gains from investment", refers to the proceeds obtained from selling the investment of interest. Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken.
- The next metric we used is PE We compared PE versus peer in 2014 as you can see PVH has a higher PE then RL and the rest of the peer groups. RL share price is cheaper indicating they are expecting higher earnings growth in the future
- Here we compared RL P/E versus its Peer group you can see PVH has a higher P/E then Ralph Lauren and the rest of the peer group.
- A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments.
- Discounted cash flow model would suggest RL is worth far more than its current stock price. Using bull case estimates, a 9% WACC, and a 3% long-term growth rate, our bull case DCF calculates RL is worth $261/share. Secondly, RL looks undervalued on a relative P/E basis, using just consensus estimates. It has not benefitted as much from the multiple expansion experienced by the broader market over the last two years. RL peer valuations have expanded significantly over the last two years, similar to the S&P, while RL’s has not. Today, RL’s P/E puts it below the peer group average when it historically has traded at the top of it. This suggests RL may be undervalued.
- Our bear case also contemplates RL investment spending rising more than expected Slower than expected growth in China or in the accessories category likely results in increased investment spending, hurting margins. 2014-2016 period could resemble 2003-2005 when RL was in licensee-cleanup mode and margins fell 200 bps. Lastly, since part of the margin story relies on the sales story, if sales don’t come through, margins won’t either.
- RL’s US business accounts for 63% of sales. Its European business is 21% and Asia 13% of the revenue mix. US handbag sales growth acceleration is the source of possible upside surprise; otherwise, we encounter little debate on the US growth trajectory. A key to the European growth outlook is, ironically, better sales to Chinese tourist consumers, and accessories growth. Lastly, in Asia, Japan is a low growth market. The region’s growth forecast depends on sales to Chinese customers in greater China and Southeast Asia. In addition, Asian customers’ first engagement with foreign luxury brands is often through accessories.
- **No pension obligations
- Optimal Debt Ratio is 50% Optimal over interest coverage ratio
- How many times you can pay your interest
- 30% is around the industry average
- Bonds that will mature in 2018 Share repurchase will increase the value of the company
- Based on the research and peer group analysis of capital structure through the various ratio’s that were looked at, we think 30% is the optimal ratio for RL going forward. Long Term Bonds Currently Have Low Interest Rates Ralph Lauren has one the lowest debt in its industry so we believe taking on more debt would not be a problem.