RL: The Market Is Not Recognizing The Risk

Takeaway: Stocks don't go up when sales slow, costs increase, capex goes up materially and the stock is at 20x EPS. A textbook 'investing year.'

Conclusion: We like what RL is doing, but the near-term financial implications will not be pretty and EBIT growth trajectory and RNOA will suffer. Even though this impact will likely be temporary, investors will need to wait until near the end of this calendar year until the risk profile improves. Until then, valuation matters.



We're surprised that RL was not down more on its 4Q print. Yes, the company overdelivered -- in typical RL fashion.  But there are enough factors that are changing negatively on the margin that we think will make  RL a good candidate for multiple compression in the sloppy quarters that lie ahead in the upcoming fiscal year.


We like this company as much as we ever have. It continually reinvests in its intellectual property to elevate the retail experience and gain share -- something that has worked for RL without fail.

Case in point…we kept a little scorecard of all the times that retailers and brands mentioned the words 'omni-channel' in press releases and earnings calls this earnings season. We stopped count at 100, and no, it did not take us long to get there. This has officially become the biggest cliché buzzword since 'supply chain' made it on to the scene 15 years ago. We swear that half of the execs talking about omni-channel don't even know what it means (if there even is a universally-understood definition). They're just following the cool kids.


Ralph is one of the cool kids.  It did not discuss 'omni-channel' once on its call or press release. Why? The reality is that it has been implementing a true omni-channel strategy for much of the past five-years…at a time when no one knew what it even was. Now RL is implementing retail and e-commerce models that others will be trying to implement in another five years. Simply put, we think that RL will continue to be a winner.  


But this is one of those years where the negatives to the story are likely to outweigh the positives. Specifically…

  1. FX will be a meaningful headwind in FY14 -- especially given RL's significant exposure to Japan.  Check out the Yen's move over the past six weeks. Not good.  FX is a $75mm hit to EBIT for the year.
  2. RL's Global SAP implementation, Korean e-commerce rollout, acceleration of retail rollout -- including NY flagship. There's another $75mm hit to EBIT this year.
  3. Capex is going from $276mm last year to up to $450mm in FY14 -- that's one of the biggest capex increases we're seeing out of anyone in retail.


In fairness to RL, it has proven to be an exceptional steward of capital in the past, and we have no reason to think that will change this year.  But the reality is that the $150mm in extra costs puts RL in a hole for 13% EBIT growth. This would be ok if we could justify solid double-digit top line growth as an offset -- but the reality is that we cannot (even if partially due to FX). So we've got slowing sales, eroding margins, and a step-up in capex. Any way we cut it, we can't justify the combination of these factors leading to any form of multiple expansion.  

Treasury Yields vs. Initial Claims

Takeaway: The US labor market is improving significantly and yields are reflecting these improving economic conditions.

We like to look at the non-seasonally adjusted (NSA) jobless claims numbers. There’s not a lot of distortion there. Year-over-year NSA claims improved to -8.8% y/y from -1.32% y/y last week.


Meanwhile, rolling NSA claims deteriorated marginally w/w going to -7.78% Y/Y from -8.59% last week as the big, week of 4/19 improvement rolls off.  


Bottom line: The US labor market is improving significantly and 10-Year Treasury yields are reflecting these improving economic conditions. 


Treasury Yields vs. Initial Claims - 10Y vs NSA claims 052313

Trade of the Day: EVEP

Takeaway: Keith reiterates the short call on EV Energy Partners (EVEP) at $41.95.

We are reiterating our energy analyst Kevin Kaiser’s short call on EV Energy Partners at $41.95. The company is an oil and gas property MLP. They have a funding gap. That's a big problem.


Trade of the Day: EVEP - EVEP

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Keith's Top-5 Tweets Today

Takeaway: Stocks, Goldman Sachs and Doug Kass.

Almost everything on my shopping list is saying, wait - you can buy me lower

@KeithMcCullough 3:17 PM


Sometimes doing nothing is the hardest thing to do - but precisely what you should do

@KeithMcCullough 3:06 PM


You have to be kidding me on the Goldman call here - its raining, so they now forecast rain

@KeithMcCullough 10:45 AM


When my signal and my research team are immediate-term bearish; my decisions to not buy become a lot easier

@KeithMcCullough  10:38 AM


@KeithMcCullough Sincere congratulations - you performed both the roles of market obstetrician and mkt mortician with precision in 2013. @DougKass 5:32 AM

Retweeted by Keith McCullough



Q2 top-line growth should be weak, again


  • Despite an improvement in US consumer discretionary spending and sentiment trends in 2013, domestic gaming continues to lag.  Demographic headwinds are to blame, in our opinion.
  • US domestic gaming revenues (excluding Indian casinos) growth has been slowing since Q3 2012 despite the recent opening of new casino markets
  • Q1 2013 US gaming revenues grew a pathetic 0.5% YoY; on a same-store basis, Q1 revenues dropped 4.2% YoY
  • For the mature regional gambling markets, April same-store revenues tumbled 4% YoY, in-line with our projections.  We believe May revenues could be flat, followed by further declines in June. 



The Case against Consumer Staples Stocks

It’s been a tough Q1 (and then some) for many staples investors that have to make a living generating alpha on the short side, or at least have to try and have their shorts go up less than their longs.  As with most market moves, there are multiple factors to which we can point as contributing causes to the run up in consumer staples:

  1. Investors chasing yield
  2. Inflows into low volatility ETFs
  3. M&A speculation in the wake of the HNZ acquisition
  4. Declining commodity prices and the associated expectation for improvement in gross margins
  5. Investors skeptical of the broader market rally and playing staples as a “safe” way to be long

Conspicuous by its absence is any case for the valuation of the consumer staples sector, broadly.  Valuation is always a tough one – it doesn’t matter until it matters, then when a stock heads lower (or higher, as the case may be), people point to valuation.

The Case against Consumer Staples Stocks - Sector PE 5.23.13


Generally speaking, we like to see stocks heading higher as estimates head higher - that has not been the case.  Through Q1 earnings season, the "average" staples company missed revenue expectations by 0.4% and beat EPS by a meager 3.3%.


The Case against Consumer Staples Stocks - Q1 EPS Summary


We have long made the case that investors have been using the staples sector (and utilities) as bond proxies.


The Case against Consumer Staples Stocks - Yield Spread 5.23.13


The Case against Consumer Staples Stocks - XLP vs. 10 yr. 5.23.13


With interest rates starting to creep higher, we may start to see money flow out of the consumer staples sector that was chasing yield and not invested for (or with, quite frankly) any fundamental view of the sector or the companies.


We also believe that certain stocks have benefitted from the inclusion in low volatility ETFs and associated money flows into those ETFs. 


The Case against Consumer Staples Stocks - CPB and CLX 5.23.13


The Case against Consumer Staples Stocks - GIS and KMB 5.23.13


In recent weeks, inflows into these ETFs have become decidedly less one directional.


The Case against Consumer Staples Stocks - Low Vol Inflows


M&A speculation is more difficult to argue against.  We think some names continue to make sense over longer durations as potential targets of either activists (MDLZ - known) or strategic investors (BEAM, HSH, POST, DF).  We have always viewed the possibility of some sort of transaction as another reason to own a stock, but not the primary reason (unless you happen to work on a special situations desk, then have at it).  Therefore, names such as CPB or even TAP, that have benefitted in part from low-quality speculation remain squarely on our least preferred list.


As to commodity prices, we believe that the companies in our universe will see a benefit, but on a lag (3-12 months, depending on the hedging programs).  However, current multiples appear to be baking in a whole lot of good margin news, that may be fleeting in terms of duration given the competitive environment.  Most staples companies can't stand prosperity, and are likely, in our view, to deal back margin in an effort to support top line momentum, which is still faltering.


Where does this leave us?


Quite frankly, it leaves us with a long list of names where we have a hard time seeing how the marginal investing dollar makes money at current levels.  Our least preferred list is long and not so distinguished:


  1. KMB
  2. TAP
  3. CPB
  4. PM (more of an issue with the strength of the dollar)
  5. CLX
  6. CL
  7. GIS
  8. MKC

What we like remains largely unchanged:


  1. ADM
  2. CAG
  3. NWL
  4. BUD
  5. DF
  6. SPB

Call with questions,



Robert Campagnino

Managing Director





Matt Hedrick

Senior Analyst

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