WRC: Peaks Are Processes, Not Points

The bull case here is best represented by the reported financials. The company smoked numbers for the 7th quarter in a row, appears, printed a 22% sales growth rate, 236bp improvement in GM rate, AND levered SG&A on top of that. Mix those together and out pops a 74% EBIT growth rate. Layer on incredibly bullish statements about the global business, input cost containment, and that WRC is not feeling the impact of any form of regional slowdown. A very powerful concoction indeed.

It’s very easy to get caught up in the ‘beat/miss vs. expectations game’ as well as all the noise around door openings and product launches. I sat on this thing for way too long today trying to make sense of it. But there are several MAJOR questions I have that are better answered by simple mathematics.

The key questions I have revolve around FX, sourcing, and margins. WRC noted that FX was a 3.4% boost to revenue in the quarter. What I want to know is how a company with a 22% sales growth rate and 50% of sales outside of the US could only benefit by 3.4% when weighted FX change is 10-15%??

My math gets me to something closer to a $65mm top line benefit. Assuming a 30% incremental margin, this is about $20mm, or 4 points of margin. In other words, excluding this FX impact we’d be looking at 6% sales growth (not 22%), margins closer to 6% (not 9.7%) and operating profit that is flattish with last year.

How can this be good if the Euro continues to roll? What if cotton goes to a buck vs. the sub-0.70s? What if the sourcing environment continues to erode as factories close in Asia to the tune of 5-10 per day? WRC management noted that costs are under control. Everyone says that. What no one says is how they are planning for the unexpected – the extent to which they will be in the pole position when the industry acts irrationally as margins go away for the companies that have underinvested at the peak.

It’s tough for me to fight the tape on this one. Heavily shorted stocks that beat numbers don’t go down. In fact, a close above 45.01 is a bullish signal from a quantitative standpoint per Keith. Not as bullish as we see with RL. But bullish enough. Could we see WRC’s multiple defy gravity for a while longer? Yes. Ultimately, however, something’s gotta give. And when it gives, run.

Asset sales have helped margins, but not as much as FX and sourcing.

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