Takeaway: RL is setting up to be a two-bagger, or the Mother of all Value Traps. We’re inclined to think the former. It’s all ‘bout mgmt. Stay tuned.
We said earlier this summer that we liked RL as a TRADE into today’s print. Fundamentally, the call played out – though we’re about flat on the stock.
Let’s get one thing out of the way…this RL quarter was horrible. Yes, it beat muted EPS expectations by $0.10. But revenue was down 5.3%, gross profit -7.1%, SG&A UP +4.3%, and EBIT/EPS down ~40%. Think it can’t get any worse? Think again, the cash conversion cycle is sitting at 171 days, which is 26 days worse than last year. Finally, capex is up 25% this year, which is the icing on a really bad tasting cake. Put ‘em all together – P&L down 40% and Balance Sheet +25%, and you get RNOA of 13%, down 1,000bp vs last year.
Then why are we incrementally warming up to RL? When it comes to consumer brands and retailers, some of the best longs we’ve seen (ones that double, and then double again) start with
a) positive rate of change in the balance sheet, which frees up cash to…
b) improve margins while investing in the content/Brand, and ultimately…
c) accelerate the top line. The stock will usually seem expensive early on in this process, and that’s where RL is today, as it’s trading at 17x a declining earnings stream.
We’ll very rarely give any company the benefit of the doubt for being able to turn such a value-eroding algorithm around – but Ralph Lauren is perhaps one of them. The reality is that it is a brand with an aggregate value at retail of $15bn, and as the company positions its resources around its core assets on a global scale, we should see growth return, and Brand footprint go through $20bn. Specifically, as it relates to the criteria above…
a) on the Balance Sheet we should see Capex coming down next year by 25%, or about $100mm as spending on SAP, which should subsequently take the Cash Cycle down by a minimum of 25 from here (that’s $200mm in cash)
b) on the Margin line, we should see a lift from the 11.5% where it’s targeted to come in for FY16. For the record, that’s the lowest margin level –by a third – since 2005 when it faced dilution from integrating licenses(most by Jones Apparel Group).
c) better productivity in company-operated stores and e-commerce alone could add $3bn to consolidated sales – nevermind better efficiency in wholesale doors.
When all is said and done, in 2-3 years we could be looking at $9.5bn in sales, 15% EBIT margin and $11-$12 in EPS. The CAGR that would require such growth (25-30%) would arguably support a 20-25x multiple on $11+ in earnings. That’s when RL becomes a two-bagger.
All that said, we have to get comfortable with one thing, and one thing alone – and that’s management. We outlined the risks to that part of the story in our recent vetting book [LINK: CLICK HERE]. Aside from the fact that RL has the seventh oldest CEO in the S&P – and one who is more active today than ever in the day to day operation of the company, there are six new divisional presidents who need to learn their own job as well as hire and subsequently motivate teams of expensive people to be productive. That’s not a 1-2 quarter phenomena.
We’re going to take RL up another notch on our Idea List, and will further vet the management angle before adding it to our Best Ideas.
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***The roundup below is an example of our daily internal data-driven research process. Specifically, it helps our team contextualize the key economic releases and policy developments occurring across Developed Asia and Emerging Market economies on a daily basis. To the extent you'd like to be BCC'ed on such emails please shoot us a quick note and we'll add you to the list.***
- Key Takeaways:
- Lots of interesting data to grind through today, specifically the July Markit Services and Composite PMI data, which, on balance was better than I would have expected. Looking to the composite indices specifically, China, Hong Kong and South Africa ticked down, Japan was flat and India, Australia, Singapore and Russia all ticked up. Globally speaking, however, the trend of #GrowthSlowing generally remained intact in July with our #EuropeSlowing theme picking up steam (see: Hedgeye Macro G-20 Composite PMI Summary Table).
- The big news out of China today was the IMF’s decision to delay changes to the SDR basket from 1-Jan 2016 until September 2016, which buys China additional time to for necessary capital account reforms that would help the yuan meet the IMF’s definition of a “freely usable” currency. This has interesting implications for the global economy. On one hand, it may give Chinese policymakers scope to devalue, which would be as deflationary for manufactured goods [globally] as it would be inflationary for raw materials. For more details, refer to the following: “China SDR Discussion” and “Is Consensus Right On China?”. All told, we do not, however, think a devaluation is imminent as Chinese policymakers remain [at least rhetorically] committed to achieving reserve currency status for the yuan sooner rather than later.
- Don’t look now, but suddenly Indian equities are the best performing factor exposure within the EM Equities asset class (see: slide 19 of our refreshed TACRM presentation). Our GIP Model had been calling for #Quad3 [marginal] stagflation here in the third quarter, but that’s not being confirmed by the first batch of 3Q data or in real-time market prices across the commodity space (which Indian CPI is unduly hostage to). Specifically, India’s Services and Composite PMI readings ticked up big time in July and call attention to the stimulus being thrust upon the Indian economy as a result of falling food and energy prices. If the bounce is sustainable (i.e. the SENSEX and EPI register bullish on our TREND duration signals), then we can get behind this narrative. For now, we are not inclined to chase given the elevated risk of a FOMC policy mistake in September.
- As expected, the Bank of Thailand kept its one-day bond repurchase rate at 1.5% – in line with consensus. They probably want to cut given that both the finance ministry and BoT have recently cut their growth forecasts, but the baht is weakening substantially (-3.9% MoM) on a commensurate acceleration in capital outflows amid consensus speculation that the Fed is gearing up to hike rates in September. With Thailand’s economic growth slowing precipitously (see: Composite PMI, Exports, Industrial Production, Retail Sales, Consumer Confidence, GIP Model), we expect such trends to continue and view the +2% WoW bounce in the SET Index as a short-selling opportunity in the THD.
- JUL Caixin Services PMI: 53.8 from 51.8
- JUL Caixin Composite PMI: 50.2 from 50.6
- IMF delays making change to SDR basket until September 2016 (StreetAccount):
- An IMF staff paper on the 2015 SDR basket recommended delaying changes to the basket from 1-Jan 2016 until September 2016 as it reviews the current composition of currencies.
- The IMF said the review would help determine whether the yuan met the definition of a ‘freely usable’ currency. MNI cited a conference call involving a senior IMF official, who added a number of issues had to be resolved before adding the yuan to the basket.
- China's policy banks to place CNY1T bond to fund infrastructure projects (StreetAccount):
- Sources told the Economic Information Daily that China Development Bank and Agricultural Development Bank of China will privately place special bonds with the Postal Savings Bank of China.
- The first CNY300B of a planned CNY1T will be used to establish an equity fund to invest in big infrastructure projects.
- The sources said that the projects will be chosen from a list submitted by the NDRC.
- Later, MNI cited analysts who said that the increased reliance of the government on banks reduce the chances for system-wide easing.
- A separate FT article highlighted the policy banks' heavy exposure to domestic infrastructure and property markets.
- Cai says GDP only needs to grow at 6.5% (StreetAccount):
- The People's Daily cited Chinese Academy of Social Sciences deputy head Cai Fang who noted that the economy needed to average 6.5% annual growth during the 13th five year plan (2016-2020) to meet the goal set in 2010 of doubling GDP.
- Cai said that this is achievable, and the paper noted that the government has started to draft its 13th five-year-plan.
- JUL Services PMI: 51.2 from 51.8
- JUL Composite PMI: flat at 51.5
- Corporates outperform regional peers (StreetAccount):
- Bloomberg reported that 159 of Japanese companies included on the Topix have reported better-than-expected results, while 97 have missed.
- The article noted that only 74 companies included on the MSCI Asia Pacific ex-Japan have beaten estimates, while 96 have reported results below expectations.
- Although it noted that the strong corporate results have not yet translated into the domestic Japanese economy, analysts see continued profit growth over the next two years.
- JUL Services PMI: 50.8 from 47.7
- JUL Composite PMI: 52 from 49.2
- JUL AIG Services Index: 54.1 from 51.2
- JUL WPI: -10% YoY from -9.4%
- JUL CPI: -0.7% YoY from -0.6%
- 2Q Real GDP: flat at 4.7% YoY
- QoQ: 3.8% from -0.2%
- 2Q Real GDP: flat at 4.7% YoY
- Thai Baht Weakens Toward 2009 Low as Central Bank Holds Key Rate (Bloomberg)
- Thailand’s baht fell toward a six-year low as global funds sold the nation’s assets and the central bank left borrowing costs unchanged ahead of a possible increase in U.S. interest rates.
- The Bank of Thailand kept its one-day bond repurchase rate at 1.5 percent Wednesday, a decision predicted by 21 of 23 economists in a Bloomberg survey. Global funds have pulled a net $157 million from stocks and bonds this week as the finance ministry cut its 2015 economic growth forecast to 3 percent on July 28 from an earlier estimate of 3.7 percent. Exports have contracted for six straight months.
- The economy’s recovery is expected to maintain a similar pace to the second quarter for the remainder of the year, the monetary authority said in a statement today. Headline inflation is likely to have bottomed out and will pick up in the second half, it said.
- “The monetary policy stance now is accommodative and will continue to be accommodative to support the economy,” Assistant Governor Mathee Supapongse told a news briefing. The central bank “will stand ready to utilize an appropriate mix of available policy tools to support the economic recovery.”
- The central bank has decided to lower its economic forecasts and will announce them next month, Mathee said.
- The finance ministry last week cut its forecast for GDP growth this year to 3 percent, which would be among the slowest in developing Asia. Exports, which make up the equivalent of more than half the economy, may contract 4 percent, it said.
- Thai Baht Weakens Toward 2009 Low as Central Bank Holds Key Rate (Bloomberg)
- Other Asia
- JUL Composite PMI: 51.3 from 51.1
- Hong Kong
- JUL Composite PMI: 48.2 from 49.2
- Other LatAm
- JUL Services PMI: 51.6 from 49.5
- JUL Composite PMI: 50.9 from 49.5
- South Africa
- JUL Composite PMI: 48.9 from 49.2
- JUL Business Confidence: 87.9 from 84.6
- Other Emerging Markets
- Miscellaneous Links
-Darius Dale, Director
Takeaway: MBA Purchase activity picked up +3% in the latest week, but remains down (slightly) on a 3QTD/2Q basis.
Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.
Today’s Focus: MBA Mortgage Applications
July Closes Strong: A mini grand finale for July Purchase demand with applications rising +3.3% WoW to close out the month. On a year-over-year basis growth accelerated to +22.9% against still easy comps, marking the fastest rate of growth YTD. On a quarter-over-quarter basis, growth in 3Q is currently tracking down -0.7%.
A Tale of Two RoC's: So, the rate-of-change setup is showing an interesting, marginal shift. Both sequential and year-over-year acceleration in purchase activity characterized the first half of the year, but now, with the data cresting on an absolute basis, sequential growth in 3Q is tracking negative while year-over-year growth is accelerating against trough 4Q comps.
Notably, growth comps for Purchase Applications (which are used as a ST direction barometer for Pending Home Sales) are showing convergence to zero about 3 months behind PHS with comps in pending home sales steepening in 3Q (relative to 4Q for Purchase Apps). In thinking about the comps dynamic we’d put greater emphasis on the setup for PHS.
Swing-Factor: Rates – whose capricious oscillations between breakout and breakdown remain the largest short-term swing factor to price performance and lead marginal (upside & downside) risk to fundamentals - retreated another -4 bps WoW to 4.13%.
Rates are now down -13 bps off the highs of late June and while mortgage rates in 3Q remain elevated relative to 2Q15 and 1H15, financing costs remain a ~4% tailwind to affordability relative to 2014 at current levels (see Affordability table below)
About MBA Mortgage Applications:
The Mortgage Bankers’ Association’s mortgage applications index covers more than 75% of mortgage applications originated through retail and consumer direct channels. It does not include loans delivered through wholesale broker and correspondent channels. The MBA mortgage purchase applications index is considered a leading indicator of single-family home sales and construction. Moreover, it is the only housing index that is released on a weekly basis.
The MBA Purchase Apps index is released every Wednesday morning at 7 am EST.
Joshua Steiner, CFA
Christian B. Drake