Not much in this RL quarter to get excited about one way or the other. The market already made that abundantly clear. While there were a few interesting takeaways for us on the specific business units and growth levers, the big question for us is simply when the time will be right to step up and make a definitive long call on RL. We don’t think it’s a question of If, but When.
Simply put, virtually every negative factor associated with the investment case around RL can ultimately be tied back to the company transitioning from one long-tailed cycle of repurchasing licenses/regaining control of the brand, to accelerating organic growth of its content on a global scale. Opportunities don’t come along very often where the stock of a quality company is out of favor due to the near-term financial impact of the company doing the right things to re-fuel growth. Operating profit – in absolute dollars – just hit a 4-year low with the quarter that RL reported today. The growth algorithm was horrible. Sales +3.3% (closer to flat excluding Chaps), EBIT -6.2% and EPS -7.6%. Not much to get excited about, and certainly not what one expects from a quality company like RL. But that’s precisely why the stock is trading at 16x earnings – near the biggest discount to Nike in the modern history of both companies. It’s also why the short interest is up 240% in six months.
We still have a lot of work to do on this one. Specifically, this ‘investing period’ everybody talks about is a lot more than that. It’s a major shift in direction for the brand(s), company, management and infrastructure. The question in our mind is whether this takes another 2-3 quarters to take hold instead of 2-3 years. If it’s the latter, then this stock is going nowhere but down. But ultimately, if our model as outlined below is correct, then we’re going to see this company earn $10.00 per share next year, and $16.00 in year five of our model. As it exits ‘investing mode’ we’ll see organic growth accelerate to the high single digits, margins blow through prior peak to 18%, $5bn of cumulative free cash flow (which we have buying back stock), and RNOA approach 40%. Today the stock is trading at 16x next year’s earnings, and less than 10x EPS in year 5 of our model. That’s a story that not only offers considerable downside if our initial model is right, but long-term upside to $300. With a story like that, we’ll let the consensus bicker all it wants about Polo stores and Ricky bags.
