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RL: A Huge Beat HAS TO Happen


Tomorrow’s print should show that RL will earn ’11 EPS a year early. The sentiment suggests that the market knows this. But RL remains in bullish TRADE and TREND with upside to $86.11... not a short yet per KM’s risk management models.

It’s been a while since my confidence on a name has been so birfurcated heading into an event as I am with RL’s 3Q (Dec) EPS.  On one hand, RL will absolutely blow away the number tomorrow. We’re modeling $1.28 vs. the Street at a buck. Similarly, our 4Q estimate is $0.96 vs the Street at $0.79.  Top line is turning on the margin (helped in part by newly consolidated Asia business), both revenue and margin compares are increasingly easy, and capital intensity is easing. When all is said and done, RL should earn the Mar’11 Street estimate a full year early and make people look to $5.50-$5.75 in EPS power in Mar ’11.

So what’s not to like about that? Hardly anything. In fact, RL is one of the poster children for a company that invested in its P&L and balance sheet over the past two years when the world was falling apart. Yes, it took it on the chin with margins, but now will enter harvesting mode and show outsized growth in revs, earnings, cash flow and returns.

With names like this, we’re increasingly not valuation-centric. Why? They DESERVE to be expensive. A global brand name with a bullet-proof balance sheet and a proven track record for executing a simultaneous top and bottom line-driven mid-teens EBIT growth rate and 20%+ RNOA?

What do you pay for that? History shows us that RL is a typical ‘feast or famine’ apparel company in that when times are tough it is valued as a lowly apparel brand, but when it is beating expectations it is quickly valued as a luxury brand. Today we’re looking at the latter. If I take my estimate – which is a moonshot above the consensus, it suggests about 17-18x p/e, or about 15x on March ’11 numbers. This also equates to about 8x an above consensus number 2-years out.

Is this justifyable? I think so. But with more Buy ratings than anytime since June 2007 (8 Buys, 6 Holds, 0 Sells), short interest resting at the lowest level since Dec/07 and having just come down precipitously over the past six months (now at 6%), and with management as net sellers above $80, it’s pretty darn tough for me to justify adding to any position here. Even though we’re expecting a monsterous beat, we’d like to see it be a more controversial one to play on the long side.

But before getting cute on the short side, keep in mind that the positive fundamentals will be there, and Keith’s models suggest that RL remains in bullish TRADE and TREND with upside to $86.11.

-Brian McGough

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