It's Time to Stop Worrying About PVH!

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PVH Corp. (NYSE: PVH), formerly known as Phillips-Van Heusen, has had a tough month. The New York-based parent company of Tommy Hilfiger, Calvin Klein, Van Heusen, and Bass has slumped over 12% in the last four weeks, despite posting robust earnings on March 28. Analysts and investors are worried that PVH’s soft outlook for the next quarter and fiscal year point to acquisition digestion problems with its recent Warnaco Group acquisition. However, I believe that PVH's long-term growth potential is bright, despite near-term challenges.

Should investors consider buying PVH at its current depressed price, since industry peers Ralph Lauren (NYSE: RL) and Perry Ellis (NASDAQ: PERY) have also shown signs of stronger growth in their recent quarterly earnings, or would it be more prudent to wait for sentiment regarding PVH to improve?

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A fine fourth quarter

For its fourth quarter, PVH’s adjusted earnings per share rose 34% to $1.60, while revenue rose 6.7% to $1.64 billion. Both top and bottom line growth topped analyst expectations for $1.50 per share on revenue of $1.59 billion.

By comparison, Ralph Lauren’s profit rose 27% to $215.7 million as its revenue rose 2.2% to $1.79 billion. Perry Ellis, which is much smaller than its two rivals, reported a profit of $4.4 million, more than double the $1.8 million it earned in the previous year. Revenue also rose 13% to $258.3 million, driven by stronger sales of its golf lifestyle apparel.

Positive earnings from these three companies reveals a surprising trend in retail apparel -- while kid and teen brands such as Aeropostale and Abercrombie & Fitch have struggled, adult brands have flourished.

Sales growth by segment

Tommy Hilfiger, the company's largest business segment, posted 9% sales growth to $891.1 million. Its North American business grew 11%, while its international segment reported 8% growth. Same-store sales rose 5% and 9%, respectively, in North America and Europe. Operating profit rose 45% to $101.8 million as production costs declined. Tommy also reported higher prices and higher sales volume, indicative of solid pricing power.

Calvin Klein was PVH’s top performer during the quarter, posting 14% sales growth to $317.4 million. Sales were primarily driven by growth in North America, new store expansions, and the added benefit of an extra week in the quarter. However, same-store sales declined 2%. Operating profit rose 5.0% to $70.1 million, which were slightly weighed down by higher advertising expenses.

Heritage Brands, which include Izod, Van Heusen, Bass and Arrow, was PVH’s worst performing segment, posting a 2% sales decline to $427.7 million. The company attributed a 4% impact to its exit from the Izod’s women and Timberland wholesale sportswear businesses. However, operating profit more than doubled from $10.5 million to $26.6 million, since its margins increased due to the elimination of those two lower-margin businesses.

PVH has a notably more diverse portfolio of products than Ralph Lauren, which primarily focuses on its Polo Ralph Lauren brand. Perry Ellis owns a more diverse group of brands such as Rafaella, Cubavera, C&C California and Penguin.  

Although all three of PVH’s segments fared well, Ralph Lauren, which also recently eliminated its unprofitable Rugby brand, outperformed all of PVH’s segments with 12% same-store sales growth in its most recent quarter.

The $2.9 billion question

However, the question weighing on the minds of PVH investors these days is its profit growth in the coming year. PVH’s massive $2.9 billion acquisition of Warnaco, which closed last month, is expected to weigh heavily on earnings in the current quarter and all throughout the next fiscal year.

Prior to the acquisition, PVH already controlled Calvin Klein’s sportswear and higher-end collections, but acquiring Warnaco gave PVH the rest of the Calvin Klein clothing portfolio, which includes its lucrative denim and underwear businesses.

PVH CEO Emanuel Chirico has mentioned that the Warnaco acquisition will already cost more than it originally anticipated. Chirico claims that Warnaco had underinvested in the business for many years, neglecting necessary upgrades and consolidations of its stores as it rapidly expanded.

As a result, the integration, which was originally planned to take 15 to 18 months, will now take an estimated 24 to 30 months to complete. Excess inventory in Asia and North America also needs to be cleared, which will weigh on margins further. Chirico also noted that Calvin Klein’s image as a higher-end retailer had been weakened by its prevalence in off-price channels, which has led to a decline in sales at department stores.

Therefore, the company intends to invest in more in-store boutiques and a more aggressive marketing campaign to reclaim lost ground. It has made rebuilding and expanding its denim and underwear business a top priority.

For the year ahead, PVH expects to earn approximately $7.00 per share, missing the analyst consensus of $7.42. However, PVH forecasts revenue of $8.2 billion, ahead of the consensus estimate of $7.67 billion. The Warnaco acquisition is expected to dilute PVH's full-year earnings per share by at least 25 cents, which could still rise given the cost and scale of the restructuring initiatives.

Fundamental growth

That leads to the final question -- margins. Although PVH’s operating margin rose 250 basis points to 11.0% in the previous quarter, the road ahead looks less certain. Let’s compare PVH’s margins to Ralph Lauren and Perry Ellis over the past three years to gain a clearer perspective.

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Ralph Lauren is the clear leader here, with PVH as a close second. Meanwhile, Perry Ellis is the obvious loser, with single digit operating and profit margins that look dangerously close to unprofitability. A look at top and bottom line growth, however, yields surprising results.

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PVH’s triple-digit top and bottom line growth over the past three years has far outpaced its rivals, despite weaker margin growth. Therefore, investors shouldn’t be too worried about PVH’s diluted profit in the coming year, as long as it keeps up its top line growth.

The Foolish bottom line

Although Ralph Lauren initially appears to be a stronger investment, PVH’s revenue growth should be enough to carry it through a year or two of declining margins. I believe that after Calvin Klein has been fully integrated into PVH’s operations, its top and bottom lines will improve dramatically, given the brand’s robust performance during the fourth quarter.

That makes PVH a solid long-term investment for patient investors willing to wait for the Warnaco acquisition to become earnings accretive. When that happens, PVH will evolve into a powerhouse apparel retailer with a flexible portfolio of brands that are better equipped to handle economic downturns than either Ralph Lauren or Perry Ellis.


Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of Perry Ellis. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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