Don't tell anyone, but I used to skip listening to quarterly earnings conference calls. In fact, I didn't even know they existed! Freshly removed from academia, I was in an abnormal situation for a Wall Street equity research analyst.
First, there was the assumption of a "coverage universe" totaling 50 stocks that consisted of companies in oilfield services, gaming, banking (I HATED covering Washington Mutual and Fannie Mae), and retail sectors (note that an investment bank analyst, after years of paying dues as an associate, may launch on 10 companies and add a new company or two over the course of five years).
Second, was to launch coverage on 15 more companies, which consisted of talking with management teams, doing the normal Securities and Exchange Commission due diligence process, model building, and writing research reports. All of these tasks, including a notebook filled with reports, were to be done in two weeks. I kid you not. I have the mental scars to lay stake to my claims. Keep in mind that I had just learned the very essence behind the outputs to a discounted cash flow model, something that is assumed to be required coursework in college. Umm, yeah.
Against this tear-evoking backdrop, is it any surprise that the virtues of listening to an earnings call went unappreciated? I was some kind of content-producing machine. Let me say, though, that for the average investor, unable to have a fireside chat with a management team, queuing up an earnings call is essential to investing properly. However, I have a funny feeling inside that a good portion of retail investors do not listen to earnings calls, for they are overwhelmed by trying to trade the news tick by tick. Hey, I get it.
When an investor does listen, I fancy that he or she is unsure how to analyze properly the material being pushed out by slick-sounding executives and eaten up by usually not-tough-enough analysts. It's important to understand the motives of each party first: Management is hesitant to admit errors in judgment, and analysts are afraid of getting the cold shoulder to conduct client meet-and-greet sessions. These conflicting interests by public voices streaming over a video feed leaves the average investor at a severe disadvantage, unless the mental toolkit exists to lock into the buzzwords of legitimate positivity (buy the stock or more of it) or impending disaster (sell the stock or avoid it altogether). For those always wondering why big moves to the upside are being missed or the portfolio is torpedoed by an error in timing, plugging into earnings calls and analyst/shareholder conferences for a few potential names on the watch list is a requirement, not an option.
Let's use provocative teen apparel retailer Abercrombie & Fitch (ANF) as a template for successfully navigating an earnings call. The company's stock has officially lost its sex appeal in the eyes of Mr. Market, falling 13% Wednesday following a 22% plunge Nov. 3, both stemming from what the Street tends to coin "a poorly delivered quarter." Unquestionably, the results were a flat-out disappointment of epic proportions, despite management boldly assuring that it alerted the Street and investors on the second-quarter earnings call that rocky waters were arriving in the harbor. I was on that call, and being real, the optimism and financials presented by Abercrombie management clearly outweighed the negative aspects to the story. Like any earnings call, I went into Abercrombie's latest results with this basic checklist:
- Sales: Why the sudden reversal in positive trends? Short-term blip or lasting occurrence?
- Margins: What is the reason for the degree of contraction that was worse than management's commentary implied on the second-quarter earnings call?
- Will things fundamentally get better quickly? If so, is the stock's selloff overdone?
- Will things fundamentally get better by the first half of 2012? If so, I will place ANF on my watch list for an entry point on further weakness.
In putting my attack plan to the test, I still believe Abercrombie is to be avoided near-term, in spite of the approaching single-digit price-to-earnings multiple (discount to sector) on a global retail brand that has a cash-rich, debt-free (excluding leases) balance sheet.
- Europe: Sales slowed "somewhat" in the third quarter. Contagion from peripheral European Union countries to seemingly stable countries has increased since summer, so traffic and sales to Abercrombie's namesake flagship and Hollister stores should slow further in the fourth quarter.
- U.S. average unit retail prices were admittedly lowered too much, yet comparable-store sales moderated sequentially and lagged competing chains. The message here is that the consumer is viewing the price/value equation as misaligned.
- A new wrinkle of information was that sales at international tourist destination flagships were cannibalizing, or eating into, each other. Given the robust capital outlays associated with this type of store and Street optimism on their sales run rate, I did not want to hear this development.
- Average unit retail prices at flagships are expected to be taken down for spring 2012 with costs not receding noticeably until the second quarter of 2012.
- Inventory increased 33% year over year and is planned to rise by a higher percentage at holiday quarter end. Some analysts were quick to note that inventory reflected in-transit receipts and inflation. I agree to an extent, but the fact is that the company is sitting on excess inventory that will require previously unplanned promotions.
- No definite action on outstanding 2012 EPS guidance. The Street is in the process of bringing estimates down to earth, but there is still what amounts to an earnings warning waiting in the wings for late February.