EPS Revisions Challenge My Call For a Week

I’ve been noting for the past month my view that retail’s cash flow trajectory will meaningfully improve in 2H.

Last week’s earnings revisions challenged my view, as outlined in the chart below. This was largely the result of revisions at Nike, and to a lesser extent Abercrombie, and Ross Stores.

EPS Revisions Challenge My Call For a Week - 3 30 2009 6 08 41 AM

My confidence level remains high, however, as commentary from these companies are contributing to the factors that I think will cause cash flow to bounce. Again -- I am NOT making a call on the consumer, but am simply modeling that the delta in the negativity of consumer spending (less toxic is good in my model) occurs simultaneously with stabilizing gross margins, and a  cost-reduction cocktail of absolute SG&A and capex cuts. (See my March 5th note “I’m Getting Fundamentally Bullish” for more quantification).

The big question heading into 2010 will be who cut costs because they could, vs. who cut because they should. We’ll see plenty of weak companies cutting into bone this year, and they’ll be the next shoe to drop.

I’m drawn to the quality companies today who I know are investing in the right places for the right reasons, such as Ralph Lauren, Under Armour Lululemon, Hibbett, and (dare I say) Liz Claiborne. Hanesbrands also fits the bill. I don’t like those who are cutting in all the wrong places, such as Ross Stores, Iconix, Sears, Carter’s, Jones and Gildan. The challenge here is that this latter basket of companies will also show a reversal in cash flow trends, temporarily masking the damage they are doing to their base business. I’ll be working closely with Keith to game the sizing and timing on these fundamental ideas when the group looks more ‘shortable’ and/or when the near-term fundamentals for each of these names present an opportunity.