Ralph Lauren Corp.’s midtier brands have the best profit margins at the company by far, and Urban Outfitters Inc.’s namesake brand is currently achieving among the lowest operating margins in specialty retailing.

Those were just two of a series of eye-opening takeaways in a report on segment margins prepared by the analyst team at Wells Fargo Securities as part of its “Retail Weekend Reading” series.

Although a number of companies break out segment profitability — such as VF Corp. by coalition and PVH Corp. for Calvin Klein, Tommy Hilfiger and its Heritage Brands unit — Wells Fargo used company data, management commentary and its own research to estimate profitability for nine firms that do not, including Nordstrom Inc., Gap Inc. and Chico’s FAS Inc.

The section of the report on Ralph Lauren was subtitled “Luxury Could Be Pressuring the Operating Margin Rate.” It’s estimated that midtier brands such as Polo and Denim & Supply accounted for about 81 percent of the company’s 2014 sales of $7.45 billion, or about $5.9 billion, but, with an operating margin of about 17 percent of sales, represented over 90 percent of earnings before interest and taxes (ebit), or about $1 billion.

By contrast, the luxury group, including Purple Label and Black Label, generated 11.4 percent of sales, about $850 million, but, with its 5 percent ebit margin, about 3.8 percent of segment profit. The tabulations include contributions from licensing, which accounted for about 2 percent of last year’s corporate revenues.
The 17 percent margin for midtier brands “is favorable relative to peers in the space,” the analysts wrote, noting that the margins in the more mature U.S. business are likely higher “and one of the highest in the industry, which is not surprising given the strength of brand.”

By contrast, segment margin at PVH’s Calvin Klein unit was 15.4 percent and VF Corp.’s Outdoor & Action Sports coalition generated a 17.3 percent margin.

While the Urban Outfitters unit struggled as Anthropologie and Free People prospered in 2014, Urban Outfitters is expected to end the year with an ebit margin of 10.9 percent overall, with Anthropologie and Free People leading the firm with margins of 18 and 17 percent, respectively. The Urban unit, however, is expected to do no better than 1.6 percent, meaning that Urban and Anthropologie, both responsible for just over 40 percent of sales at just under $1.4 billion each, will have a wide discrepancy in their share of the company’s segment profit — nearly 70 percent for Anthropologie versus just 6 percent for Urban.

“Because we do not believe that the problems [the Urban brand] faces are secular in nature, we believe this points to a big margin opportunity in 2015,” noted Wells Fargo analyst Paul Lejuez in the report.

Gap poses a parallel to UO’s experience, with Gap and Old Navy responsible for similar shares of sales — about 37.8 percent at Gap and 40.2 percent for Old Navy — but a disparity in ebit contribution, estimated at 52.7 percent of the projected $2.1 billion ebit total in 2014 versus just more than half of that amount — 27.2 percent — for the struggling Gap brand. Wells Fargo estimated Old Navy’s margin at 16.4 percent and Gap brand’s at 9 percent.

While the analysts viewed Old Navy’s margin as impressive, “it also could be argued that [Old Navy is] overearning versus the rest of the retail field, a point of risk in 2015 as the competitive landscape is not getting any easier, with H&M continuing to grow, Primark entering the U.S. and Target focusing more on improving apparel.”

Both Gap and Urban are expected to provide updates on full-year and fourth-quarter performance today.
Nordstrom is projected to end the fiscal year with sales of $13.3 billion and an operating margin of about 10 percent. Full-line stores were estimated to have an operating margin of 9.5 percent versus 12.5 percent for Rack. In the Wells Fargo model, Rack accounts for 24 percent of sales but about 30 percent of operating profit.

Margins are higher at Rack because of lower rent and store expenses, offset to a degree by lower merchandise margins.

Wells Fargo observed that Nordstrom’s overall operating margin has fallen from a peak of about 14 percent in 2006, but attributed much of the decline to its ambitious investments in digital, mobile and related technologies. The report assumes that “other” businesses, including HauteLook and Trunk Club, are “slightly better than break-even” and responsible for about 3.6 percent of sales, or under $500 million.

The 9.5 percent estimate for full-line store profitability is slightly lower than Macy’s 10.2 percent level.

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