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Idea Alert: Covering RL

Conclusion: We’re keeping a TRADE a TRADE. The company is doing everything right, but it’s not immune. Earnings power is underappreciated, but we think we have time. For now it’s rangebound.

 

Keith covered our RL short this morning on the print. We shorted it into the print as a TRADE – simply because top line expectations were high, SG&A is headed up, they just lost their CFO, the global macro climate presented a perfect opportunity for RL to guide down, and this is a consensus long.

 

After a sharp initial sell-off, the stock is hanging in there reasonably well – most notably it is holding Keith’s $144 level. Breaking (and holding) that level would put $138 in play.

 

There’s not much that really changed our thought process here. We like the name more and more the further we go out in duration, and we have the earnings in our model to prove it. But the realization of $12 in EPS will not happen in a vacuum.

 

The reality is that this is the first time in three years that RL missed to this magnitude in its own retail stores. Comps of +1% do not exactly instill the confidence we need to bank on a 2H top line acceleration. They can make it up in the (higher margin) wholesale business, but let’s face some facts… if any power brand like RL wants to find some dollars, they turn to wholesale, not retail. Retail is the best barometer of a brand’s trajectory.

 

One of the positives is that they are beginning to see the benefit from input cost relief, and that should only improve from here. Unlike brands like Carter's, Hanesbrands, and Gap we think that Ralph has the brand power to keep most of the margin upside. But we’re mindful about ‘granting’ both margin upside AND top line acceleration starting 90 days out. That’s a long time to wait with a lot of unknowns.

 

Ultimately, where the Street shakes out over the next day or two with earnings estimates will be critical.

In the interim, Keith will do what he does…manage risk around a high conviction longer-term research call by trading a range which today stands at $144-$153.

 

Based on the research we have in front of us today, we’d need to see that $138 to step up and buy right now.

 

There are two things that could change that:

 

1) Time. We think that as each day draws closer to getting past 2Q, the stock has a better shot of working as margin pressure eases relative to last year's compares.

 

2) The Research. The reality is that the volatility in the business environment has never been greater than it is today. If there’s anyone who will be left standing, it will be RL. But there’s simply limited visibility past the upcoming quarter (where RL likely sandbagged). Could comps at retail be up 10%? Yes. Down 10%? Yes. We’ve got low single digit comps in our model for the remainder of the year. If we gain confidence in them later in the quarter, then all else equal, the stock might make sense here for the intermediate-term. But we don’t see the need to rush.

 

 

We have included below our RL Idea Alert from Monday, August 6

 

Idea Alert: Covering RL - RL Levels


We shorted RL into the print for a TRADE. To be clear on this one, there’s a sharp delineation between where we like RL over each duration. In the event of a sell-off, we'd be looking for a point of entry once the dust settles to get involved with what could be $12 in earnings power. 

 

TAIL (3-Years or Less): This is one of our favorite TAIL ideas, as we think that the consensus is underestimating RL’s 3-year earnings power by  nearly a dollar. When we add up the opportunities by country, product category, and most notably – by channel (ie dot.com), we think that people are underestimating the leverage inherent to this model.  Specifically, we’re looking at nearly $10 in EPS next year, and over $11.50 the year after. A 10% premium to the market suggests a stock near $175. A 1x PEG is $200+ over 2 years.

 

TREND (3-Months or More): RL still has a full 75% of its (March) FY left to go, so the company will be guarded into the print. RL laps European category expansion (intro of Polo FW), Denim & Supply, FX, and double digit retail comps – which are tougher to bank on this year.

 

TRADE (3-Weeks or Less): The company has every reason in the world to offer up a cautious outlook – given all that’s going on in the world – especially Western Europe (it has minimal exposure to China) and the clear trend of other companies putting up weak numbers. Add in the Olympic spending, tough wholesale and store productivity comps, and our analysis that stretches to find more than 10% of CFO changes that end up being a near-term positive earnings event, and we’re more inclined to be on the negative side of this print. This is a perfect ‘buy on pullback’ stock. 


NKE: Building An Olympian

NKE: Building An Olympian - usgym nike

 

 

The XXX Olympics have been exhilarating to watch, make no mistake about it. It is currently beating out the 2008 Beijing Olympics with ease. It’s also the premier event to put advertising dollars to work and to generate buzz around new products. At the forefront of the marketing blitz is Nike (NKE).

 

With nearly every top notch/famous athlete that’s competing using Nike, there’s room for all sorts of marketing and advertising from Nike. We believe that two specific campaigns, both from Nike, are going to make a massive impact on the public.

 

 

NKE: Building An Olympian - nike VOLTbest

 

 

The first campaign is a bit on the subliminal side. If you’ve noticed - Hedgeye Retail Sector Head Brian McGough did during the first week of the games – nearly every team are wearing bright, neon green Nike shoes. Known as the Volt line of footwear, this is the shoe uses Nike’s new FlyKnit technology and go for about $150 a pair and everybody seems to love them. It didn’t hurt that Michael Phelps chose to wear them for his interview with Bob Costas on NBC this past Sunday. With Phelps’ massive size and contrasting black pant, you couldn’t help but stare at the shoes. See below for a screenshot.

 

NKE: Building An Olympian - michael phelps and bob costas

 

Speaking of Phelps, this brings us to our second marketing campaign that Nike uses: building an organic brand around an athlete.

 

Any company can throw some clothes and a check at an athlete, hope they perform and walk away. That’s simple and doesn’t resonate as much with its consumer base. What you need is something emotional and outstanding. Per Brian McGough:

 

The best brands will take the stories that inevitably rise from performance (in this case, the Olympic Games), and craft stories around key athletes to create an emotional connection to the consumer AFTER the fact. When Liu Xiang, the Michael Phelps of China (he won the gold medal on the 100m hurdles eight years ago in Athens – an unprecedented feat for the Chinese) dropped out of the race last minute due to injury on his home turf in 2008, Nike turned the disappointment upside down, and created a marketing message that made consumers sympathize with the rigors of training at such a high level for one’s country.”

 

The result? Running revenue accelerated in China. Building brands is important for business; how you do it is everything.


You Can’t Sugarcoat It

You Can’t Sugarcoat It

 

 

CLIENT TALKING POINTS

 

REGISTER THE SENTIMENT

The bulls enjoyed their high-fiving of 1400 on the S&P 500 yesterday. That’s fine, but we’ve got two indicators that are cause for concern. Going back to the VIX, it’s about to seriously test our long-term TAIL support level of 14-15. With the VIX this low, you can expect the market to break down soon. The second indicator is the Bull/Bear Spread spiking back up to +1810bps wide to the bull side. Bears have been eviscerated from the spread, down to 25.5% vs 27.7% last week. A change is coming soon and the futures dropping well below that coveted 1400 level is key. If we drop below 1381, watch out for a bumpy ride.

 

 

THE NEXT WAVE OF REGULATION

There’s a problem going on in Britain right now – three to be exact. Standard Chartered is at risk of losing its New York banking license due to this Iranian money laundering scandal that broke this week, HSBC is dealing with a similar money laundering issue and Barclays is still wrangling with the LIBOR scandal. There’s now a rift being created between regulators and politicians in the United States and Great Britain. Expect further witch hunts down the road as we prepare to investigate one another’s banking institutions.

 

 

_______________________________________________________

 

ASSET ALLOCATION

 

 Cash:               DOWN                           U.S. Equities:    Flat

 

 Int'l Equities:   Flat                                Commodities:    Flat

                                  

 Fixed Income:  UP                                Int'l Currencies: Flat

 

 

 

_______________________________________________________

 

TOP LONG IDEAS

 

JACK IN THE BOX (JACK)

This company is transitioning from cash burn to $75mm annual free cash flow generation thanks to completion of a reimaging program and refranchising of JIB units. Qdoba is the leverage; a maturing and growing store base will bring higher margins. We see 8.5% upside over the next 6-9 months.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG            

 

FIFTH & PACIFIC COMPANIES (FNP)

The former Liz Claiborne (LIZ) is on the path to prosperity. There’s a fantastic growth story with FNP. The Kate Spade brand is growing at an almost unprecedented clip. Save for Juicy Couture, the company has brands performing strongly throughout its entire portfolio. We’re bullish on FNP for all three durations: TRADE, TREND and TAIL.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“@KeithMcCullough you guys killed it short side with $mcd $coh $rl, congrats” -@lipscrl

 

 

QUOTE OF THE DAY

“A lifetime is more than sufficiently long for people to get what there is of it wrong.” – Piet Hein

 

 

STAT OF THE DAY

Market expects Chinese corn production to rise Friday to 197-200mmt vs 195mmt last month.

 

 

 


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MGM: OWW AND PCLN CONTRADICTION

Priceline and Orbitz are down pre-market 16% and 9%, respectively.

 

 

We'll have more analysis on this later but PCLN and OWW are getting crushed pre-market as bookings and other leisure travel metrics are worse than expected.  Commentary from these online travel companies do not exactly corroborate MGM management's commentary that, "We've already seen an improvement in customer trends here in the third quarter."

 

MGM's stock popped yesterday on an in-line quarter and the positive forward looking commentary (post June).  That looks like some commentary that should be faded.  We remain below the Street for 2012 and 2013 MGM EBITDA - 2% and 11% lower than consensus. 



Magnificent Investing

“Another thing that freaks me out is time.  Time is like a book.  You have a beginning, a middle and an end. It’s just a cycle.”

-Mike Tyson

 

This week I enjoyed a few days off in the Banff and Lake Louise region of Alberta in the heart of the Canadian Rockies.  As part of my tour, I hiked up to view the Takakkaw Falls in Yoho National Park.  The falls are the second highest natural falls in Canada at 245 metres.  In Cree, the word Takkakaw is loosely translated to mean “it is magnificent” and is an apt description of this natural wonder.

 

Interestingly, while much of North American is being adversely impacted by record hot temperatures, Western Canada seems to be thriving.  Specifically, the crops appear to be in excellent condition.  In fact, the Canadian Wheat Board issued its first crop outlook for the 2012 – 2013 season and in it said the following:

 

“Wheat fundamentals are favorable to prices. World wheat production is forecast to fall by over 40 million tonnes to 646 million tonnes.  A weather-related shortfall in Russia, Ukraine, and Kazakhstan is the main driver behind the global production decline. The U.S. corn belt has been hit by a severe drought, resulting in dramatic declines in corn and soybean production potential.”

 

We Canadians are known for our subtleness and this report from the Canadian Wheat Board is no exception.  To translate: it is going to be a record year for Canadian farmers because of shortage of supply of both wheat and corn globally.  This shortage of supply is primarily being supported by drought like conditions in both the U.S. and key growing areas in Europe. As a result, many agricultural commodity prices have been in a mini bull market.  As an example, the corn ETF, aptly named CORN, is up more than 50% in the last two months. Being on the right side of a trade like this is what I would call: Magnificent Investing.

 

Personally, I haven’t studied global warming enough to either be a proponent or opponent, although this year certainly gives some credence to the concept. That said, Keith and I have at times discussed our longer term investment view of Canada and even presented this view to various municipal governments across Canada.  A key component of this view is obviously the vast resources of Canada as typified by the agricultural production capabilities and the Saudi Arabia like oil resources in Alberta.  But another important potential tailwind for Canada is weather patterns.

 

UCLA Geography Professor Laurence C. Smith has done much of the work that underscores our long term investment view of Canada.  In his book, “The World in 2050: Four Forces Shaping Civilization’s Northern Future”, Smith highlights some of the key forces driving economic share gains of the Northern Rim Countries, or as he calls them NORCs.  A key point in his thesis related to NORCs is that their share of crop production will increase dramatically if and when the world becomes warmer because they will be less directly impacted by an increase in temperature.  His prediction is for this trend to really have an impact by 2050, even though it sounds a little like 2012 . . .

 

No doubt climate cycles can be challenging to invest around, though industrial cycles can be much more predictable and create longer term (in our models TAIL duration) investable fundamentals.  Our recently hired Industrials Sector Head Jay Van Sciver has spent more than a decade on the buy-side and a key component of his investing framework is that if you get the industrial cycle right, you’ll get a lot of other things right.  An example he uses in his presentation is being on the right side of U.S. electrical transmission infrastructure investment cycle.  A couple of points to consider:

  • In the down cycle from Q1 1992 to Q1 2000, the SP500 returned 243%.  In that same period, the primary players in this industry, Copper Industries, Hubbell, and Thomas & Betts, returned on average 25%.
  • In the up cycle from Q1 2001 to Q1 2012, when investment in transmission infrastructure was accelerating, the SP500 was up 51%.  Meanwhile, the key players noted above were all up more than 300%.

I’ll say it again, if you get the cycle right, you’ll get a lot of other things right.

 

Van Sciver’s launch presentation on June 27th was a bearish call on the airline cycle.  Call him lucky or good, but as we highlight in the Chart of the Day, airline stocks have basically been in free fall since he launched.  In fact, speaking of Magnificent Investing, one of his least favorite names, UAL, is down almost -20% in that period.  His next deep dive will be on the global truck OEM market and he will be hosting a conference call on August 16th to discuss. Ping us at or contact your sales person if you are an eligible institution and would like to join this call and review Van Sciver’s work.

 

In our global macro research, a key theme we’ve been hammering on for the last few years has been the global debt super cycle.  An important point of this cycle is that as government debt accelerates past 90% debt-to-GDP, economic growth slows.  This morning’s data from Europe does little to change our debt cycle thesis. Spanish 10-year yields are back pushing that 7% line at 6.98% and so there’s no surprise that the IBEX 35 is down -1.9%.  Further, German June exports were down -1.3% year-over-year and German industrial production was down -0.3%.  Clearly, even a relatively well situated country like Germany cannot escape the growth slowing debt cycle.

 

Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $107.34-111.83, $81.89-82.69, $1.23-1.24, and 1, respectively.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Magnificent Investing - Chart of the Day

 

Magnificent Investing - Virtual Portfolio


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