RL: Focused As Ever

Takeaway: RL’s not cheap at 20x. But valuation – high or low – is not a catalyst. RL is as focused as we’ve ever seen. Tough to bet against it.

Ralph pulled another Ralph by simply smoking the consensus with an adjusted $2.45 vs the Street at $2.15E. As good as this was, let’s not be blind to the fact that company lowered guidance for the Street would come in 10% below last year. In reality, earnings were about flat (excluding a one-time tax hit), which is nothing to write home about for a growth company. Of course, RL tempered guidance in 2H – not because it should, but because it could. Let’s face some facts…the company guided for Gross Margins to be down this quarter -175bps-225bps, and yet they actually came in UP by +29bps. They likely felt the need to keep estimates grounded and looked for the best place, which is the top line.

Past the expectations game, there was something that jumped out at us pretty clearly – which was the sheer number of strategic initiatives going on inside the company right now. For people who think that that it can’t grow organically anymore, there’s enough brewing today that should prove themwrong for quarters to come. For example…

  • Launching Japan e-commerce this past quarter
  • Continuing to alter the Chinese retail footprint – a massive undertaking
  • Closing the Argentina business
  • Closing Rugby. This has been a Halo brand for the college crowd, but the reality is that a) it is not making money and b) Roger thinks that he can do a better job with his core brand. (We love when companies close ancillary concepts to re-direct capital to the core). With 14 stores and its associated e-commerce business, we estimate this to be only a $20-$25mm business equating to a ~30bps top-line hit (though margin enhancing).
  • Accelerating growth in Denim & Supply
  • Increasing distribution of accessories category with key partners
  • Likely evaluating Chaps, which is about a $400mm business at retail. Chaps is currently in the hands of Warnaco, which is being acquired by PVH. There’s a change of control provision in the contract. You can bet your bottom dollar that RL will either negotiate a higher royalty, higher investment hurdles, or will take the brand in-house.
  • All of this is happening at the time when Chris Peterson is taking the reigns as the company’s new CFO (we think that his pedigree represents a significant upgrade in the role of CFO inside RL – they nabbed one of the most eligible candidates in corporate America).

So yes, actual growth was nonexistent in the quarter, but with Gross Margins expansion more than offsetting continued SG&A investment spending and top-line likely continuing on their current trajectory, EPS and cash flow should re- accelerate to a 20%+ rate in 2H versus 0% in 1H. This should carry into next FY as the initiatives above start to bear fruit. We’re realistically looking at $8.00 this year and between $9.00 and $9.25 next year. There’s no way we could call RL cheap at 20x 12-month forward earnings. But valuation – either high or low – is not a catalyst. RL is about as focused a company as we’ve ever seen it. It’s tough to bet against a company like this.

What Drove the Beat:

While top-line results declined slightly less than expected, gross margin improvement more than offset higher investment spending driving upside in the quarter and EPS of $2.45 (adj for $0.16 in 1x discrete tax item) vs $2.05E.

RL: Focused As Ever - RL S


Accountability and Outlook: Here’s a look at RL’s variance between guidance and actual, as well as
outlook for F13 vs expectations:


RL: Focused As Ever - RL Outlook Table


Highlights from the Call:


Tale of Two Halves: While margin performance came in better than expected, still expect further improvement in 2H


Impact of Sandy:

  • 81 stores (~20% of store base) closed
  • e-commerce interruptions
  • Reopenings staggered through the week
  • Approximately 12 stores still closed
  • Have lost modest Q3 revs so far and expect some lingering impact

Closing Rugby Concept:

  • Have decided to close the Rugby brand
  • Closing 14 related stores and e-commerce site
  • Expect pretax charges of $20-$30mm in 2H (75% in Q3)

Regional Performance:

  • Americas remain strong
  • Securing incremental distribution with key partners (handbags, footwear, D&S, etc)
  • Europe still challenging - South more than North
    • Will look to change demand as it materializes
  • Asia operating environment has been softer than they accounted for
    • Performance at free standing stores outperforming wholesale doors
    • Upgrading shop locations and assortments
    • Opened 7 new stores in region (expect 14 in 2H)
    • Launched .com in 2Q in Japan

Core Polo Brand Positioning:

  • Looking to accelerate its positioning and evaluating growth opportunities - primarily int'l
  • Could be in form of increased distribution, marketing, and branding ideas
  • 'I think you'll hear more to come in the next couple quarters about strategies we hope to employ to focus on those.'

China/Asia Store Growth:

  • Pace of opening in Asia - have opened 7 in 1H (tgt of 20 in F13) on pace for another ~13 stores in 2H
  • Primarily located in malls
  • Flagship opportunities are harder to come by
  • Most stores this year in 5k-10k sq. ft. range
  • Should have a good read on customer by middle of the spring

Gas Prices, Hurricanes And Dining Out

Nationwide, gasoline prices have declined -1.3% week-over-week. However, it’s worth noting that the Northeast will be affected by a shortage of gas in the aftermath of Hurricane Sandy. Sandy will likely impact restaurant traffic trends over the next few weeks, similar to what happened in the South post-Katrina. Tight gasoline supplies led to a decrease in miles driven which, in turn, led to a deceleration in restaurant traffic.


Gas Prices, Hurricanes And Dining Out  - retailGAS

Where's The Beef?

Your favorite fast food joints and restaurants are likely to pass the rising cost of beef on to you sooner or later. Thank Ben Bernanke for devaluing the dollar and inflating the commodity bubble. As you can see, year-over-year, live cattle prices have skyrocketed from $85 to over $125. Higher prices are a negative for everyone from Jack In The Box (JACK) to Wendy’s (WEN) to Chipotle (CMG) to Bloomin’ Brands (BLMN). The fundamental outlook suggests that the strength in beef prices should continue for some time. 


Where's The Beef? - live cattle

Making It Up

Client Talking Points

Making It Up

We truly get a kick out of those who try to forecast economic data. After all - what’s the point? Show us someone who has been right more than 1/3rd of the time on the jobs number and we’ll call BS. People make stuff up, just like the jobs number. So when the number comes out better than expected and the futures rip higher, remember that it’s an election year and someone is probably making those numbers more malleable than expected.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

After a long downward slide, TCB has finally turned the corner. The margin has stabilized after the balance sheet restructuring. Loans are growing thanks to the equipment finance business. Non-interest income is more likely to go up than down going forward, a reversal from the past 18 months. Credit quality has a tailwind from a distressed housing recovery in TCB’s core markets: Minneapolis, Detroit and Chicago. On top of this, the CEO, Bill Cooper, is one of the oldest regional bank CEOs, which raises the probability that the bank will be sold. Expectations are bombed out at this point, so we think it’s time to move from bearish to bullish on TCB.


Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjos a strong position in a structurally advantaged industry and an attractive valuation.


While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road


“Only morons have "forecasts" for a jobs number the government makes up” -@KeithMcCullough


“Tragedy is when I cut my finger. Comedy is when you walk into an open sewer and die.” -Mel Brooks


$50 billion. The amount of economic losses expected because of Hurricane Sandy.

Hot & Cold

“I will have naught to do with a man who can blow hot and cold with the same breath.”



This is the coldest morning the East Coast has had to deal with since Sandy. My prayers go out to the children, sick, and elderly who have to go through this with no power or heat.


Back to the Global Macro Grind


Get’em while they are h-h-ot! That’s what the perma-bull marketers said yesterday as US stocks were having their 1st legitimate up day in the last 7 trading sessions. It’s been a long 1.5 month drought. Literally everything that didn’t work in October went straight up. All the pundits nailed it. Welcome to November.


In other “recovery rally” news – the headlines from the manic media changed, suddenly, this morning:

  1. “Anger As Fuel Shortage Hampers Recovery” –BBC World News
  2. “Scope of Sandy’s Devastation Widens, Death Toll Spirals” –Reuters
  3. “Power Restoration May Take Longer Than Expected” –New York Times

But don’t worry – there a plenty of Keynesians who still believe in Broken-Window Economics who will be out peddling stories this morning about how America is seeing a jobs and hurricane recovery.


We have no idea what this morning’s US Employment Report will bring. Only a moron would have a “forecast” for a number that the government makes up. China gets that – so they are going to start making up their numbers a little faster too.


China Daily noted that the National Bureau of Statistics said China will “revise its GDP accounting methods” in line with international standards. Perfect. So the China recovery is going to get really h-h-ot now!


As our hawk-eyed Asia analyst Darius Dale wrote to our Institutional Clients yesterday, this is the “most bullish data point emanating from China today – inclusive of the sequential acceleration in Manufacturing PMI and the PBOC’s record $6B injection into Chinese money markets this week.”


“From what we’ve noticed, international standards for GDP accounting = shoot first; ask questions later (i.e. report the most positive headline figure you can and subsequently revise it down 1-3 times in the coming months/years). This bodes well for a sequential uptick in China’s YoY GDP growth in 4Q12E!”


In other economic “recovery” news out of Europe:

  1. Spain printed a PMI reading of 43.5 for OCT vs 44.6 in SEP
  2. Germany’s slowdown stayed the same in OCT with a PMI reading of 46.0
  3. Italy’s PMI remained well below the “50 recovery” line at 45.5 OCT vs 45.7 SEP

No worries there. Markets in Europe were relatively hot this week (other than in Greece). These poor Greek guys are having a heck of a time reconciling the media’s “recovery” rumors with economic reality. Greek stocks dropped -15% from October 22nd’s YTD high to yesterday’s close, leaving this -11% down week as the worst week for the Athex Index in 4 years.


Across asset classes, as always, there are plenty of Hot & Cold risk management signals to consider this morning:

  1. SP500 climbed back above its 1419 TREND line of support; but remains below its TRADE line of 1432 resistance
  2. US Equity Volatility (VIX) closing at 16.69 remains in a Bullish Formation; could go to 20 if this jobs report is bad
  3. US Dollar Index continues higher this morning, +0.35% to $80.32; bullish on both our TRADE and TAIL durations
  4. EUR/USD trades down to the low-end of our immediate-term $1.28-1.30 risk range (bearish TAIL remains)
  5. Hang Seng +1.24% last night makes it the 1st major index in Asia to make higher-highs
  6. KOSPI, Nikkei, Sensex were all up > 1% too, but are all making lower-highs, not confirming the Hang Seng
  7. Germany’s DAX and France’s CAC making lower-highs versus September, again
  8. Russia’s RTSI Index remains under crash-test assault, -0.3% this morning (-18% from #GrowthSlowing’s to in MAR)
  9. CRB Commodities Index remains in a Bearish Formation at 296 (Bernanke’s Bubble)
  10. Copper, down -0.5% this morning to $3.47/lb remains in a Bearish Formation as well
  11. US Treasury 10yr Bond Yield of 1.73% remains bearish TRADE and TAIL w/ resistance at 1.75% and 1.91% respectively

And, finally, US Equity Fund outflows (ex-ETFs) continued last week with another -$1.4B yanked. So, was yesterday’s 1-day move a head-fake? Are you feeling hot or cold?


I’ll let the market answer the 1st question for me today. If we confirm 1419 in the SP500 and the VIX snaps 15.54, that would be bullish. On the second question, my arthritic hockey knuckles are officially numb as I sign off from a chilly Westport, CT.


Out immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $107.49-109.96, $79.68-80.47, $1.28-1.30, 1.70-1.75%, and 1, respectively.



Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Hot & Cold - EL


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