This RL print clearly challenged our Short thesis. RL put up $0.90 per share vs the Street at $0.60. Revenue was mixed, margins looked good relative to expectations (still down materially yy), and inventories are correcting (though still high). Revenue growth was flat to last quarter, but up about 1% reported. Asia had the best growth in the quarter up 13% reported and 29% in constant currencies. North America down 3% reported and up 2% constant currency. Guidance looks a bit light on revenue for the upcoming quarter and the year, but that’s to be expected in Quad 4 and this global retail malaise. The company guided to full year revenue growth at constant currencies in MSD, with Asia up double digits, Europe up low single digit, and North America down low single digit. Expecting some margin improvement due to the increased AURs, freight benefit, while having 50-100bps of FX headwinds for the year. Our biggest dig here is how pricing is driving the top line. AUR was +12% for the quarter, yet constant currency revenue was +9% and gross margins were down 175bps. How are margins down 175bps when AUR is up 12%? While FX and freight were headwinds in the quarter, that still doesn't explain away the lack of flow through of the AUR to GM. Yes, the company is elevating the brand, which we applaud, but its failing to bring new customers into the fold. Its trading down to a younger age (usually a positive), but is either firing its older customers or is not bringing enough new consumers in to get to growth in transactions. Net/net, it appears that the customer base, especially in its core US market, is shrinking, which we hardly view as bullish. We're modeling LSD revenue growth for the year and minimal margin improvement. We have EPS coming out at about $8.00 for the year, about a buck below the Street. At a low double digit multiple the stock still has about 25% downside from here. Is this our best short call? No. We have other names with much more downside. But we’re hard pressed to be buyers here when the core consumer base is shrinking, and 100% of revenue growth hinges on price.
If we put our ‘TAIL risk’ hat on here with being short, it all comes down to Mr. Lauren’s exit strategy. He owns 86% of the vote through the dual class structure, and he’s 83 years old and still a critical part of the company’s design and merchandising direction and planning. The company has had discussions with European Luxury houses like LVMH in the past, but obviously nothing ever came of it. The brand didn’t check enough high-end boxes for a deal to happen. It could very well be possible that this ‘elevating the brand’ strategy has nothing to do with driving consumers to the brand, but making it more attractive to a potential buyer. Look at what LVMH did with Tiffany. That asset went through a ‘brand elevation’ period as a public company under Roger Farrah (former RL President) and then was bought by LVMH – who since doubled profits on the brand. Ralph might give two hoots about the quarter or firing lower-end consumers. He might be entirely focused on making this a take-out candidate for LVMH, Kering, or Richemont. Something to chew on…we definitely are.
