WRC: Costs Cuts -- Could vs. Should

05/12/09 03:50PM EDT

Let the debate begin on WRC. The company beat the Street by $0.27 and our model by $0.32.  The quality is not what headline suggests, but a beat is a beat, so I won't ignore that.  But pulling forward $25mm in revenue from 2Q while printing a massive 14% decline in SG&A has its clear leverage pressure points.  This says nothing about whether WRC SHOULD cut SG&A to this magnitude. The fact is, it did.  The $30mm decline in revs y/y was almost entirely offset by a $25mm decline in SG&A dollars. Yes, WRC has big Int'l exposure (i.e. FX helped SG&A), but it's so rare to see such variability in SG&A. The sustainability here and impact '10 will be THE question (i.e. is mgmt cutting off the third leg of a bar stool?).  This smells punk to me.

This name is setting up as a nice 'whack-a-mole.' Stay tuned....

On the bull side, if you like a wholesaler that is transforming into a growing retailer, driven by aggressive square footage growth and the associated mix benefit from high direct-to-consumer operating margins (20% Four Wall for CK retail) while real-estate costs serve as a tailwind, then WRC should continue to work for a while.  But, watch out for the very first instance that the rate of store growth slows and overall margin growth trends reverse. 

MAJOR CALL OUTS

  • Same store sales are slowing (meaningfully) for CK retail:
  • o April: -4%
  • o 1Q09: +5%
  • o 4Q08: +12% (+17% December)
  • o 3Q08: +13%
  • o 2Q08: +20%
  • o 1Q08: +11%
  • Raising square footage growth from 20% to 24% for the year. This looks like a classic case of opening stores to drive same store sales to keep overall momentum alive. You can't bet against this for now, but look out when new store growth slows.
  • Spent some time discussing a retail strategy for CK accessories. Clearly another lever here to drive DTC growth. Accessories currently has one free standing retail location and the total division is currently producing $100mm. This was the first mention of an opportunity to double the business over the next 3 years, driven primarily by square footage growth.
  • CEO quotes on store growth: ""If we could do more we would", "current softness in comps is a momentary aberration", we are pursuing "aggressive growth" in retail
  • Despite retail square footage going higher, Capex is going lower. Took Capex down to $35mm from just under $40mm. A nice positive.
  • Total SG&A dollars now guided to down $100mm year over year. This is a combination of the $70mm in cost cuts plus the benefit of a larger than originally expected F/X impact. The specificity around cost-cutting on the part of management was light. That's surprising given that we're only talking about a $715mm base in total SG&A for WRC.
  • Warehouse Clubs saved the day
  • Approximately $25mm in sportswear shipments were pushed into Q1 from Q2 at an above average operating margin. The impact added 5% to total revenues and approximately $0.06 to the quarter (assuming an above avg. 16% operating margin for this piece of business).
  • CK intimates also saved by shipment to the clubs at an above average margin.

 WRC: Costs Cuts -- Could vs. Should - WRC S 5 09

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