Appropriate stock reaction to RL’s print today as it put up the best and highest quality earnings algorithm we’ve seen in 19 quarters. RL put up 5% sales growth – which shouldn’t be considered heroic for any quality retailer or brand – but a stark turn for a company that has been virtually unable to grow for the better part of five years. On 12/9 we removed RL from our short list at $105 and added to our Long Bench due to our expectation for accelerating top line while the rest of retail begins to see slowing growth. That’s definitely playing out. In hindsight I should have gone flat-out long as the stock is up 20%.
On one hand, I like that the company just set itself up for another beat in its fiscal 4Q (Mar). US quality of sale continues to improve by way of higher ecomm/direct and less off-price, and the brand unquestionably strengthened globally – showing acceleration in Macro hot spots like Europe and China. Markdown allowances are down to department stores as RL has right-sized inventories in the dinosaur channel – despite the fact that women’s sportswear was called out by the Macy’s of the world as the weakest performing category. Well managed there by RL. The ecomm trend was particularly notable – growing 20% for the quarter after hitting low points of -20-30% ecomm growth in recent years. That was arguably the biggest positive in the quarter from my perspective. These drivers are likely to continue into 4Q, which flies in the face of guidance for a sharp sequential slowdown in the top line. I’ll take the over on that one. Another 5% top line will be tough, but sales likely to come in on the plus side vs guidance of -3-4%.
Ultimately this is a credibility builder for Louvet (CEO) who is delivering meaningfully on targets laid out on the June 13th analyst meeting – and he’s arguably doing so a year early, to his credit. But the flip side is that the annual targets laid out – 3-5% top line growth, 7-8% EBIT and 12% EPS growth are underwhelming as it relates to the potential at a company like RL. Management is running a SG&A-focused model – more along the lines of Louvet’s former P&G life than a killer sales-driven model like we’re seeing out of perennial winners like NKE. Yes, to be clear, I’d rather see RL far less conservative with SG&A/Marketing/R&D and more focused in delivering on a 10% top line (even if it carries greater risk of short-term failure). I understand that a top-line driven model is more volatile, but delivering on a real growth strategy (think Nike) is worth me moving out further on the risk curve on this idea, and would command a far better multiple from where I sit.
In the end, I think the company will deliver on what it says it will do – I just don’t think what it is promising is worth a premium to the 16-17x pe and 9x EBITDA multiple we see as RL finds its ‘new normal’ growth algorithm. To be clear, I wouldn’t be short this name by a long shot – especially with a $0.15 beat in the queue for its March quarter. But I need to gain confidence that my team’s top line growth forecast is light by 300-500bp before adding RL to my best idea Long list with the stock at $125. Stay tuned.
