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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