Sunday Edition: Wearing A Polo? You’ll Like This Buying Opportunity

August 13, 2017

Sunday Edition: Wearing A Polo? You’ll Like This Buying Opportunity

When reading about the fraught retail sector, I usually find myself wondering about how iconic American brands are doing. Those longstanding brands that really embody and define American style.

This week had me thinking about Ralph Lauren (NYSE: RL).

For several years, it has seemed that Ralph Lauren has been in the same boat with Michael Kors and Coach, with their products being found mostly at outlet malls and on discount racks at departments stores.

They’ve also fallen victim to the shift to fast fashion away from the kind of slower-moving and higher-priced apparel Ralph Lauren is known for.

But much like Coach and Michael Kors, Ralph Lauren knows what its problems are. The company is working on speeding up its supply chain so that it can be more reactive to new trends. It’s also ending some peripheral brands, like Denim & Supply, and putting more resources behind its namesake labels like Polo Ralph Lauren.

Closing underperforming stores and reducing wholesale distribution is evidence that the company is also getting choosier about where it sells its products, a move that should benefit the longterm health of the company.

But it’s this move that has also made quarterly earnings reports look particularly unpleasant. Case in point: revenue was down 13% from the same period a year ago on their earnings report released this past Tuesday.

And sagging sales—along with executive shakeups—have pummeled RL stock since 2013.

Source: TradingView.

But it was also this most recent earnings report that made the stock price gap higher, completing a pattern I’ll show you in a moment.

On Tuesday, RL jumped 10% on news that while revenue was down considerably from a year ago, it was down less than analysts’ expectations. Adjusted earnings per share came in at $1.11, above the $0.96 per share in adjusted profit analysts had anticipated.

Inventories fell by 31%—which they were able to do with a minimum of discounting and liquidations—as the company worked to improve inventory turnover and efficiency. This and the company’s move to reduce discounts has bolstered profitability, and saw gross margin adjusted up by 210 basis points to 63.2%.

The fact that inventory fell by 31% from a year ago without discounting is particularly encouraging because it says that there is still demand out there for the brand. And with the company’s strong balance sheet and $1.1 billion in net cash, it gives me hope that Ralph Lauren will come out on the other side of the “retail apocalypse.”

Now, back to RL’s chart. What I’m seeing on this chart is an island reversal bottom pattern.

Source: TradingView.

An island reversal bottom is a pattern marked by an exhaustion gap down on increased volume, and a breakaway gap up after an “island” of price action. Typically, the two gaps at either ends of this pattern occur at almost the same price level.

This pattern is a very good indicator of a reversal of the previous trend and marks that a change in sentiment has occurred, which is very good news for RL.

In RL’s case, it looks like the breakaway gap that completed the pattern may be filled or partially filled by a pullback as a result of the action, but that doesn’t invalidate the pattern.

For a minimum target on this pattern, measure from the base of the candle of the gap down to the end of the wick of the lowest candle in the island, then project that up from the base of the candle on the gap up. In RL’s case, this gives us a minimum price target of around $108, which is roughly 29% above today’s (Friday’s) price.

For further convincing that this pattern has established a solid bottom, I looked to the weekly chart. What I found is that this bottoming pattern occurred at the 78.6% retracement of the last bull run on RL, confirming that this very deep correction is likely finally over.

Source: TradingView.

As always, if you’re considering adding RL to your portfolio, do your due diligence before buying.

If you’re not ready to commit to RL, another option would be to buy call options at $85. A call option gives you the right to buy, but does not obligate you to buy, shares at a specified price in the future whether the price of the stock is lower or higher than that price at the end of the option period. Doing so would mean that if in 6 months the price of RL is at $60, you can pass on buying the stock at $85, or if the price is higher than the call price, you have built in returns if you choose to exercise your option.

A little food for thought this Sunday. And if you feel like shopping, I recommend snatching up any Ralph Lauren polos still on the sale rack. They might not be there much longer.