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RL: Numbers Are Still Too Low

I’ve been convinced that RL is under-earning, and 1Q results strengthen my view that there’s more to come. RL guided to $4.00-$4.10. I still think it prints better than $4.50 for the year.

To be clear, this was NOT a great quarter – despite half the sell-side congratulating management on the call for beating lowered guidance. Yeh, RL printed $0.93 vs the Street at $0.71, but sales were up only 4% and EPS was about flat vs. last year. Nothing to write home about.

That said, there were several things I liked, and another that raised an important potential concern.
Pros…
1) Comps were decent at 4%, and wholesale managed to be flat despite a truly abysmal US whole business (which by my math was down around 20%). This helps show the geographical evolution of this company.

2) Inventories were down 6% despite a meaningful boost in FX, and a horrific retail environment. On top of this, Gross Margins were up, meaning that RL did not simply take it on the chin with margin to clean its books. The chart below says it all. After 10 quarters of fixing distribution and investing in product, we’re finally starting to see the benefit on RL’s P&L. The P&L trajectory is on solid footing.

3) The cash cycle overall improved by 9 days. Not only did inventories improve by 6 days, but DSOs were down by 2, and payables were up by 1. Not bad, Ralph.

My Biggest Concern. There is the potential for us to look back 2-3 quarters down the road and view this quarter as the peak for RL from an FX standpoint – not immaterial when a third of cash flow comes from Europe. See my 7/25 and 8/5 posts outlining 1) materially slowing retail sales in Europe and 2) Europe serving as the buffer for Chinese apparel imports as the US shifts to other countries on the margin. Bottom line = growth is slowing in Europe, costs are headed higher, and any organic growth and/or FX benefit could be history for US brands/retailers.

The saving grace for RL is that in this quarter, it ONLY BEAT AS MUCH AS IT HAD TO! The company delivered SG&A rather meaningfully (by about 275bp) as it took up SG&A to plow capital back into the organization to keep brand momentum going. If the FX factor reverses course later this year, RL is one of the few brands that can pull back on key levers to gain share without meaningfully sacrificing profitability.

RL guided to $4.00-$4.10. I still think it prints better than $4.50 for the year.


US Dollar Right At the Goal Line This Morning

The US Dollar is surprising me, trading higher again this morning, so far, up at 74.13. Given Bernanke's directionless and dovish view, I was expecting to see a selloff here. That certainly doesnt mean things can't change, however.

The 200 day moving average is where a lot of the slower moving capital lies. I generally do not use this line to manage my portfolio, but I am always aware of it in order to understand risks of potential behavioral breakdowns/breakouts.

The 200 day moving avg for the US Dollar Index is 74.23. I have attached a 3 year chart just to remind you how many times we have toyed with this goal line, and failed.
KM
  • Can The US Dollar Breakout With Bernanke Pandering To the Doves?
(chart courtesy of stockcharts.com)

Japan Is Getting Darker, Faster...

The Japanese government made explicit comments last night that assure me, at the very least, that economic trends are deteriorating as fast as I thought they would. Testing the 109 level, the Japanese Yen is hitting it’s lowest level relative to the US Dollar since January, as a direct result.

Japan's Finance Minister, Ibuki, actually used the word "stagflation", joining Ben Bernanke as the other major central banking head to do the same in recent weeks.

My short term target for the Nikkei is 12,807.

*Full Disclosure: I remain short Japan via the EWJ (ETF).
KM
  • Japan's Nikkei Is Breaking Down
(Chart courtesy of StockCharts.com)

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.64%

US Consumer Sentiment Continues Track Employment

This morning's weekly ABC/Washington Post consumer confidence reading reverted to its negative "Trend" line. This correlates positively with the sharp downward movement in last week's US jobless claims. Both have an inverse correlation with rising US corporate and personal bankruptcies.

At -49, the ABC confidence readings look primed to test their all time lows. This week's negative move is more negative if you consider that this occurred in the face of dropping oil prices.

KM

Happy Days

Shark jumping at the top of this US market’s downward “Trend”, and bedlam at the bottom. That’s a borrowed “Happy Days” line that I have been using, and boy did we see some bull sharks bloodying the short selling waters yesterday. That was the biggest rally we’ve seen since April. Volume was strong; breadth was impressive. The S&P 500 closed at 1284, right back at the level where I moved to 85% cash.

If you handed me Bernanke’s transcript before the FOMC release, I would have moved to 95% cash. Obviously that would have been a mistake for an hour or two of post communiqué trading. Thankfully, nobody did! Despite his opting to pander to the political winds, and do nothing but keep the easy money card in play, the US Dollar held its august to date gains, as did US Treasury yields. Commodities markets didn’t stop going down either – the CRB Commodities Index closed down another -74 basis points on the day at 398. It was a very impressive day for the bulls.

With small caps racing higher, and US Consumer Discretionary stocks posting a +6% day, we have to respect the effort out there from those who think they’ve called the US market bottom. My models spit out new ranges after every 90 minutes of market trading. At yesterday’s close, I moved to an S&P downside target of 1231, and an upside one of 1292. If you are going to play this game fully invested, I think you should trade this range, aggressively.

In terms of consensus expectations, the facts have changed materially in the last 3 weeks on two fronts: Inflation and Growth. Commodities driven inflation has deflated to the tune of -15.7% from its early July high (CRB Index), while worldwide growth expectations have deteriorated materially. In the US, the most relevant flashing amber lights on my screens are the emerging bankruptcy and unemployment cycles. Globally, Asian growth stats continue to deteriorate. Japan’s Finance Minister, Bunmei Ibuki, held a press conference overnight walking through his newly found economic “forecast” for guess what? “Stagflation”. Now we have the top 2 economies in the world stagflating. That’s not good.

Trading this global tape has not been as easy as the US Federal Reserve’s monetary policy. From here, I think you’ll do just fine fading the high end of my trading range and getting longer at the low end. However, the best positioning will remain the concentrated in cash one.

The US government and banking system alike has not given me any reason to believe them, or that they have a proactive process that will allow them to protect against downside tail risk. This is most obvious in Bernanke’s tag line forecast that the Fed is "expecting inflation to moderate.” He has used this line in the FOMC statement since August 2006!

As the facts change, I do. While the aforementioned facts related to inflation and growth have changed, this alarming “Trend” of a politicized US Federal Reserve has not. Like global stock market investing, Fed watching has become a mania. Manias generally don’t end well. As this one’s confusion continues to manifest itself via volatile trading waters, I’m happy to be on the shores, watching the sharks jump.

Per our friends at Wikipedia, Shark Jumping “is an allusion to a scene in a 1977 episode of the TV series Happy Days when the popular character Arthur "Fonzie" Fonzarelli literally jumps over a shark while water skiing. The scene was considered so preposterous that many believed it to be an attempt at reviving the declining ratings of the flagging show.”

Best of luck out there today,
KM



MSSR – Eye on Operating Leases

MSSR is scheduled to report 2Q earnings tomorrow after the close and I would expect results to be less than pretty as the company does not begin to lap easier comparisons from a same-store sales and operating margin standpoint until 2H08. That being said, the street is forecasting a 55% year-over-year decline in 2Q EPS so expectations are not high.
  • As of its 1Q earnings call in early May, the company stated that it had seen Friday and Saturday dinner comparable sales stabilize after posting very negative same-store sales on those two days beginning in mid-February. Management did go on to clarify that relative to stabilizing sales on those two days, “that the group is not eroding as quickly as it was before,” which sounds less than positive. According to NPD data, the fine dining segment (includes MSSR) posted the biggest traffic declines in the March-May 2008 time period, down 4% relative to casual dining up 1%. NPD also reported that the dinner day part was the weakest segment across all restaurant categories which does not bode well for MSSR as dinner sales accounted for 75% of the company’s 2007 sales.
  • MSSR’s operating margins fell over 500 bps YOY in 1Q to 0.5% (among the lowest reported in 1Q08 for casual dining operators) and close to 450 bps sequentially from 4Q07. Management attributed these significant margin declines to a deleveraging of commodity and labor costs as a result of lower comparable sales and to there being a larger proportion of newer restaurants in the company’s portfolio, which are not as efficient at managing food and labor costs. Management expects to see an improvement in margins in 3Q and 4Q (which matches up from an easier comparison standpoint) as they become more efficient in labor scheduling and drive higher average checks from their menu focus on wild species (which generate higher price points) in 3Q.
  • Relative to the company’s development pipeline, MSSR still expects FY09 unit growth of 13%-15% on top of its 15% unit growth forecast for FY08. Management stated, “we have sought and in some cases received additional concessions from our landlords on charges and even more favorable rent terms for the 2008 and 2009 signed lease.” According to MSSR’s 2007 10-K, however, the company’s future operating lease obligations are up relative to its minimum rent expense in 2007 (in the 10-25% range), which is concerning as it relates to company margins going forward. For reference, as of their most recent 10-Ks, DRI and EAT are subject to operating lease obligations that decline each year.
MSSR's Operating Lease Obligations Relative to 2007 Expense

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