RL: Duration Setup Into 2Q


Conclusion: RL won't make you rich at $155, but if you own it for the 'uber-premium brand & company that can consistently crank out 20%+ organic annual cash flow growth over 3-yrs' factor, then look no further. 


TRADE (3-weeks or less):

After posting its first earnings miss in nearly 4-years two quarters ago, the company posted blowout numbers in Q1 and we expect another beat Wednesday albeit with more modest upside.

  • As good as wholesale results were last quarter retail sales and profitability was even more impressive and we expect retail performance to be the key driver of both top and bottom-line results again in Q2. 
  • We expect retail sales to account for +10-11% of RL's consolidated top-line growth driven primarily by the incremental contribution of Korea (+3%) as well as new store growth of +4% in addition to existing comps up +4% with the remaining ~7% from wholesale. 
  • While there is some question over how much of Q1 wholesale demand was buy-in ahead of price increases versus stronger underlying trends given ~$30mm of sales pulled forward adding +2.5% to total revenue growth (we expect some was pre-bought), we think there is less variability here relative to basic categories (a la HBI). In addition, we think concerns over demand out of Asia has been tempered in light of Hermes’ results last week reflecting robust results out of the region (+32%). Furthermore, RL's business in Asia has so many asymmetric factors that should allow it to grow despite the current climate. 

The key difference between our numbers and the Street for Q2 is that we are slightly lighter on revenues (by ~2%), but are assuming better margins as the company implemented select price increases intra-quarter. Keep in mind that RL is going with more of a hi-low strategy, where it is taking up prices on the mid-high end to more than offset sharper (and in certain cases lower) prices at the low end.


TREND (3-months or more):

There are a lot of moving parts here over the intermediate-term between calendar shifts, new store/e-commerce contributions and the addition of the Korean business, but the full-year trajectory looks decidedly positive. 


With new categories and regions coming on during the quarter from the launch of e-commerce in France and Germany, to the company’s new Denim & Supply line in August and bedding and bath businesses, we are shaking out at over 19% revenue growth for the year. 


In addition, we expect Q2 margin results to prove management’s guidance conservative as the company began taking price in the quarter. We expect the company will eat some portion of the cost increases, but also expect little to no acceleration in promotionally activity given considerably more favorable inventory compares over the coming quarters. Take a look at the SIGMA. We expect further improvement in the sales/inventory spread after four straight quarters of being negative.


TAIL (3-years or less):

No change to our view here. We think that RL has $10 in earnings power in 3 years as RL grows from being a $15bn global brand, to better than $20bn now that RL has complete control of its geographic, distribution, and product licenses. It's actually a rather boring story -- but boring is good in this tape for a mid (bordering on large) cap premium brand that can consistently grow its top line double digit and leverage it to 20% growth in cash flow. 



RL: Duration Setup Into 2Q - RL SIGMA 11 7 11


RL: Duration Setup Into 2Q - RL Sentiment 11 7 11




Bearish TAIL: SP500 Levels, Refreshed

POSITION: no position


The SP500 continues to fail at my long-term TAIL level of resistance. On these low-volume squeezes (yesterday’s US Equity volume was -25% below the 1-month average), this market is starting to develop some very bearish skew.


Bull markets are confirmed by bullish volume and the associated breakdowns in volatility. On a core 3-factor modeling basis, that’s how our model defines them anyway – and I’m not about to deviate from that risk management process anytime soon.


The corollary to a bearish TAIL (lower-long-term highs) in US stocks is a bullish long-term TAIL of volatility (VIX has TAIL line support in the 22-23 range). Volatility kills returns.


As of 11AM EST, the most important lines across all 3 durations in our model are as follows: 

  1. TAIL resistance = 1268
  2. TRADE resistance = 1258
  3. TREND support = 1216 

In other words, if the SP500 can’t start to confirm (close) this 1 zone, 1216 is going to be right back in play.


On this morning’s opening strength, I cut the allocation to US Equities in the Hedgeye Asset Allocation Model back to 0% (from 6% on the open and 12% last Tuesday when we tested my 1216). In the Hedgeye Portfolio, I have 8 LONGS and 8 SHORTS (vs last Tuesday 9 LONGS and 5 SHORTS).


Manage risk around the most probable range.



Keith R. McCullough
Chief Executive Officer


Bearish TAIL: SP500 Levels, Refreshed - SPX






The NFIB Small Business Optimism Index rose in October for a second month, implying less pessimism on the outlook for sales and the economy. The Index climbed to 90.2, the highest level since June, from September’s 88.9 and consensus expectations for October of 90.  The NFIB’s Chief Economist sounded cautious in his statement, however, saying “It’s hard to call it a recovery with unemployment about as bad as it was at the recession bottom.”





THE HBM: MCD, YUM, SBUX, DNKN, CBRL, MSSR - subsectors fbr





MCD: McDonald’s printed 5.5% global same-store sales for October versus expectations of 4.5% and guidance of 4-5%.  The U.S. division saw comps grow 5.2% versus consensus of 3.7%.  MCD Europe comps grew 4.8% versus the Street at 4.2% and APMEA came in at 6.1% versus expectations of 5.4%.  If growth is slowing in Asia and Europe is sliding into the Mediterranean, mid-single digit one- and two-year trends are better than bad.


THE HBM: MCD, YUM, SBUX, DNKN, CBRL, MSSR - mcd us oct11


THE HBM: MCD, YUM, SBUX, DNKN, CBRL, MSSR - mcd europe oct


THE HBM: MCD, YUM, SBUX, DNKN, CBRL, MSSR - mcd apmea oct



YUM: Yum! Brands’ Little Sheep acquisition has been approved by China’s commerce ministry.  The acquisition cleared China’s anti-monopoly laws.  Little Sheep is a hot-pot restaurant chain that operates in more than 400 restaurants in China.  The acquisition was worth HK$4.4 billion (US$566 million), according to Bloomberg.


SBUX: Starbucks is rolling out mobile payments in Canada today.


DNKN: Dunkin’ Donuts announced 12 new restaurants in Des Moines, Iowa. The first is slated to open in 2012 and the last in 2018.





CBRL: Cracker Barrel today began mailing its proxy statement for the company’s Annual Meeting of Shareholders to be held in December.  Chairman Michael Woodhouse also sent a letter to the company’s shareholders urging them to elect the company’s nominees to the Board of Directors and to vote against the election of Sardar Biglari.  The company’s track record, in terms of creating shareholder value over the last few years, may spur shareholders to seek some new direction.


MSSR: Tilman is to purchase McCormick and Schmick’s for $8.75 per share in cash.  This is approximately a 29% premium to the closing price yesterday.





Howard Penney

Managing Director


Rory Green


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FOSL: Quick Hit


FOSL reported Q3 EPS of $1.09 above its revised guidance of $1.00-$1.03 following the realization that the company’s string of five consecutive quarters of 30%+ top-line growth was coming to an end. This stock has been a lightning rod since. Here are a few takeaways from the release along with an updated SIGMA for clients interested/involved in the stock:



  • Clockwork SIGMA with sales/inventory spread improving on the margin. The last two quarters reflects progress that you’d expect from a mature company and suggests a return to a positive sales/inventory spread near-term.
  • Europe wholesale sales growth reaccelerated on both a 1yr & 2Yr basis. APac decelerated sequentially, but remained flat on a 2yr basis. Combined these regions account for ~40% of total sales.
  • Gross margins of 55.9% came in slightly better than expected versus guidance of ‘just above 55%’ with Q4 now expected to be flat yy. There aren’t many companies in retail that are through the other side of contracting gross margins already.


  • North American wholesale and FOSL’s DTC sales (~60% of total) both decelerated sharply in Q3. Notably, e-commerce was flat in Q3 down compared to 20%+ in each of the first two quarters of F11 – putting FOSL in the ranks of JCP with an underperforming .com business. We realize that sales in the channel were up over 60% last year, but they were up over 55% in Q4 as well so it doesn’t get much easier next quarter.
  • Q3 results and updated FY outlook implies the company is taking down Q4 by $0.03 despite increasing the FY outlook by $0.03 (beat Q3 by $0.06, taking Q4 down $0.03).
  • FOSL is the first company to revise its outlook lower due to a stronger dollar.

Management didn’t provide its update to 2011 until the Q4 call last year so we would expect the same on the 9am call. As a former ultra-growth darling of retail, eyes will be on this one today.


FOSL: Quick Hit - FOSL SIGMA 11 8 11


FOSL: Quick Hit - FOSL sentiment 11 8 11


Casey Flavin



This note was originally published at 8am on November 03, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“A plague o’ both your houses!”

-Mercutio, Romeo and Juliet


Mercutio’s immortal phrase was aimed at the houses of Montague and Capulet whose feuding led to the tragic sequence of events that make up one of Shakespeare’s most famous and timeless pieces.  The phrase has been resurrected ever since to express frustration, typically with two opposing sides of an argument. 


Franklin Delano Roosevelt, following a bloody clash between striking steel workers and the Chicago Police Department that came to be known as the Memorial Day Massacre of 1937, said that “The majority of people are saying just one thing, ‘A plague on both your houses’”.   Today, among the dearth of political leadership in Washington at such a time of crisis, many in the country are saying the same to the respective political parties.


Frustration is usually a transient feeling, sooner or later dissipated by resolution, compromise, apathy, or distraction.  As being poor became a way of life for many during the Great Depression, it seems frustration is now becoming a core component for not only the American existence, but for many people around the world. 


Conspiracy theories abound regarding the Federal Reserve and the degree of corruption that exists in America’s economic and political institutions but, Ben Bernanke’s assertion that the slow pace of economic growth is “frustrating” seems genuine to me.  I think frustration is something the country can relate to.  However, it was nearly unconscionable to me that he would used the phrase of a “bit of bad luck” when referring to the spike in oil prices and the dampening effect it had on economic growth this past year.  It was clear to us at Hedgeye that the Federal Reserve’s own policies were significant drivers of higher oil prices.       


Another political plague exists today in Europe as the never-ending saga of the sovereign debt crisis rambles on.  It has long been said by European officials that the union must be preserved and that the respective futures of the member states are inextricably linked, by both circumstance and by law.  I would view the former as being somewhat subjective and the latter as being, as was shown when Brussels consented to bailouts that may or may not be forbidden by the Maastricht Treaty, completely open to interpretation if the situation demands it.  A dramatic series of events is needed and the one certainty is that there will be pain.  Listening to politicians bending logic and essentially wasting further time with tired old solutions is becoming frustrating for Europe’s people.     


When President Obama was elected in 2008, he had successfully campaigned on a message of change.  I, like many other Americans, was taken by the message and the delivery, but it’s not possible for one person to change a compromised political system and this country is realizing now that there will be no quick fix.


This realization is all the more daunting when one considers that many of the same actors are in the same roles that they’ve been in for years.  Geithner and Bernanke are some of the most obvious examples but recent news of John Corzine possibly being culpable in the collapse of MF Global following his claim that thirteen years ago he “understood the flaws” at Long Term Capital Management better than anyone is equally disheartening.   


If repeating the same action again and again and expecting a different result is the definition of insanity, to use Einstein’s quote, then surely entrusting the same players with the same or similar responsibilities and expecting different results is also a folly.   In this respect, Wall Street and Washington D.C., are frustrating their shareholders and voters to no end.


The cast iron dogmas of the sphere of investing, as those of the policy world, are being exposed as useless.  We believe that a flexible, nimble, and data-driven investment process is essential to surviving the turbulence that is visiting the financial markets with greater and greater frequency as the unpredictable actions of governments continue to cause uncertainty.  Clearly some of the old guard in Wall Street, and Mr. Corzine is one example, have not learned to invest prudently. 


Over recent weeks, predicting whether macro factors or earnings were to be the driving force behind stock performance on any given day has been a fool’s errand.  With the wisdom of hindsight, however, I can say that macro factors have been more of a focus than earnings over the past month.  The “Greece Doesn’t Matter” television pundits have been quiet of late.  Soon the earnings season will be over and a new macro season starts.  Our “King Dollar” thesis is going to be one that we monitor closely with a minefield of catalysts heading into the holiday season.  Hedgeye has been highly accurate in calling the US Dollar over the last three years and, as Keith likes to say, “if you get the dollar right you get a lot of other things right.” 


Just as Wall Street needs a change in leadership, our policy makers need to step aside and allow new leaders to win back the confidence of the country.  The Federal Reserve’s forecast for GDP growth in 2011 is now 1.6%-1.7% versus 2.7%-2.9% prior and 2.5%-2.9% versus 3.3%-3.7% prior for 2012.  In a year, according to the Federal Reserve’s updated economic projections, the unemployment rate is scheduled to be 8.6%.  The Federal Reserve’s track record is less-than-satisfactory, so those projections certainly should not be relied upon and are likely overly-optimistic.  A mere 40 basis points of improvement in the unemployment rate is certainly frustrating.   40 basis points is of little use to the 46 million Americans now depending on food stamps for sustenance.


I can respect the experience that many of the policy makers in Washington possess and would love to someday hear or read any of their perspectives on what went wrong in the last few years.  However, given that this country is currently embroiled in a sort of economic Vietnam, I believe that the coach – President Obama – will ultimately be judged harshly for not having brought in new players in key economic policy roles.  Experience can be good but it isn’t necessarily always helpful.  As Robert Benchley said, “A boy can learn a lot from a dog: obedience, loyalty, and the importance of turning around three times before lying down”. 


Function in disaster; finish in style,


Howard Penney


FRUSTRATED - EL Chart 11.3


FRUSTRATED - Virtual Portfolio


If you thought WMS was a “show-me” stock before FQ1…



Even we were too aggressive on the numbers.  In our quarterly preview, we expressed the opinion that FQ1 was likely to be another weak quarter and that management would likely be unsuccessful in convincing investors that the story isn’t broken.  What we didn’t expect was that FQ1 would be an absolutely pitiful quarter.  On the bright side, it’s hard to imagine the quarterlies getting much worse.  CEO Brian Gamache’s characterized his company’s situation this way: “WMS has reached an inflection point."  We would say “hopefully, WMS has hit rock bottom.”


Excluding unusual charges, WMS produced $0.23 of EPS this quarter, 20% below materially reduced projections.  Not only did WMS miss for the 3rd time in a row but they once again lowered their forward numbers.  But now guidance is “conservative”.  In the penalty box, show-me stock lost all credibility; what the heck is going on?  Pick your description, they all apply, and management isn’t talking their way out of this one.


Product sales were $19MM below our estimate, although on the bright side gross profit was only $7MM below our estimate

  • New unit sales were almost 1,500 lower than we estimated with International sales just slightly more disappointing than NA sales
  • Not only were NA unit sales than our estimate, but they included 930 new units – about 700 of which came from Kansas.  We weren’t modeling the majority of those shipments for another quarter given that neither facility is opening until the March quarter and we typically assume that shipments for large openings occur one quarter in advance of an opening.  WMS must have jumped through some serious hoops to ship all their units early.  Without pulling forward Kansas, the quarter would have been even uglier.  BYI’s NA shipments only had about 150 new units – almost all from a partial shipment to Kansas Speedway - and we'll have to wait and see what IGT reports tonight. 
  • We estimate that WMS’s ship share plummeted to just 18% in the quarter.  While the F1 is normally WMS’s weakest ship share we just didn’t think that we’d see an 8% sequential drop – 5% is usually the norm.  Again, if the early shipments to Kansas were excluded or only partially shipped, share would have been even lower at roughly 13-15%.
  • Gross margins and revenues got a nice lift from the sale of an unusually high number of conversion kits which have mid to high 80’s margins. 

Gaming operations revenue and gross margin were both 6% below our estimate largely due to lower average win per day as well as more attrition in the install base than we expected.

  • Given the approval of numerous titles in the quarter, we didn’t expect an almost 280 unit sequential decline in the install base when WMS just lost 550 units in all of FY11.
  • Average win is typically flattish from the June to September quarter – we modeled a $1.50 sequential decrease which clearly underestimated the degradation in yields.

On the bright side, there was a YoY 15% decrease in R&D spend - despite management adamantly claiming they would never cut R&D -marking the first YoY decrease in R&D since March 2006.  Normalized G&A was also $2.5MM lower than we estimated decreasing 11% YoY.