WRC: A Tough Shot…But I’m Taking It

There are few events more volatile in this space than a Warnaco EPS report. Several people asked me what I’d do in advance of the numbers. Here’s my 2 cents…
This is a tough shot, but I’m going to take it. I remain quite negative on the 2-year margin outlook, but have burned myself on more than one occasion in being early on this call. But why negative now? A few considerations…

1. My model has revenue growth going from a 20%+ growth rate to a single digit rate – something I think it will be tough to beat organically with its current portfolio.

2. I maintain my view that WRC has passed too much of its incremental FX benefit to the EPS line over 5 years instead of reinvesting back into the business. With margins going from 2% to 10% over that time period, I’m confident that we’ll see a big swing the other way next year when an Obama administration inevitably takes up interest rates, and the dollar along with it. I can’t find another company with poorer positioning that WRC.

3. Aside from a sharp deceleration in revenue and margins, WRC is about to comp against 4 quarters of the biggest improvement in the company’s cash conversion cycle in its history.

4. 12% of the float is short, which concerns me – but we’re seeing it at 20-30% for better quality companies.

5. WRC beat every one of the past 9 quarters by an average of 42%. Do you think that just MAYBE the street is expecting another one? I can’t rule out a beat – though anything near recent magnitude is not gonna happen. Better yet, a guide down is increasingly likely.

6. Why should this name trade at 6x EBITDA – at the peaky end of retail today?

7. No covenant issues right now as first tranche of debt is not due until 2012. But cut margins in half (which is entirely possible) and we’re talking a very different story…