RL: Still One To Ride in ‘09

As usual, there's a ton of noise in these RL numbers, but by my math the company came in at around $0.68 vs. my model at $0.52 and the Street at $0.42. This was a clean beat all around. Revenue, margins and capital intensity all looked better than I modeled - and I was well above consensus. Was this a 'great' quarter? No - it was not. Let's face it, these guys are perennial sandbaggers, and with sales down 1% and EBIT off by 27% there was nothing to write home about here.  But all things considered, this company continues to prove that its multi-pronged execution around an extremely focused strategy is second to none.

Ok, so back to the sandbagging comment. Management came out with guidance that genuinely represents uncertainty around the global economic environment. But as I hash through my model, I get to $4.25 for next year, and $5.50 the year after. Yes folks, that's a 15% CAGR, and is 16% and 27% above where I think the consensus will shake out in '10 (ending March) and '11, respectively.

Similarly, the first quarter guidance is a bit perplexing. Double digit decline in revs with growth in operating expenses? This comes at a time when FX hurts the top line, but helps opex. To get there, I need to assume a big sequential erosion in wholesale sales AND margins, as well as a slowdown in either .com or new store productivity (unlikely when new store growth is slowing meaningfully).  In fact, if I model the company's guidance to a 'T' I can get to a 1Q estimate as low as $0.10-$0.15 per share. Call me a perma-bull, but I'm getting to a number North of $0.50.

So what DOES concern me?  FX, for one. I could care less about the negative impact RL is feeling today from FX. But anyone who 'does macro' has got to be watching the dollar, which has been in a freefall for the past two weeks. While I highly doubt that RL as an organization is a fan of weak dollar policy, this trend may set up RL for a nice little top-line and margin pop by the September quarter. But the flips side is that this is also a time when it is investing capital in Europe and Asia to fill out the next leg of its global brand expansion. I like the fact that RL has not printed a disproportionate amount of its FX benefit in recent years (unlike WRC, GES and others), but I can't escape the fact that it is potentially investing capital at a time when a devalued currency could hit incremental ROIC.

Does threaten my EPS estimates for the next 18 months? No. But realize it or not, incremental ROIC has been THE key driver to this stock over the past two cycles, and I'll be hyper focused on how proactive the company is approaching this issue this time around. This is now one of my key issue on this name right now. Stay tuned for more analysis.

RL: Still One To Ride in ‘09 - 5 27 2009 1 14 33 PM

Brian McGough