Amidst all of the kisses being blown management's way on the earnings call, allow me to interrupt with a touch of cold water on Polo Ralph Lauren (RL).
The stock is galloping pretty hard today (can never resist the puns on this company) in response to earnings and I am receiving a ton of calls today regarding my contrarian take on Polo following earnings.
First, let's refer to the pre-market note I released this morning on the Real Money Columnist Conversations following a review of the quarter.
In summary: I wouldn't characterize the quarter as amazing, rather very much reflective of why I wasn't going to recommend the name into the release. There were soft spots to the report that are at least warranting of a near-term reassessment on the company's valuation.
I am not denying that Polo delivered a solid quarter compared to the retail sector at large. The conference call offered up a couple sweet notes to my analytical ears in terms of future profit margins. In fact, I no longer even care that the last time I sat with the head of IR that he raked me over the coals (I have trained myself to never show emotion, thank you "Art of War.") But, there are reasons why I am playing the role of Dr. Brian today on the psychology surrounding Polo shares going forward.
- Polo may indeed deliver improved profit margins by 2Q13 (today's results were for 3Q12) due to cooling raw materials costs and select price increases taken in 2011. Increasing international sales mix also helps the profit margin cause. But the market has caught wind of these trends and likely outcomes, now valuing Polo at nearly 21x forward estimates (I used $8.20 per share, I expect analyst estimates to be hiked in the days ahead). That valuation level could result in a sell-on-the-news moment when Polo reports 4Q12 (which will contain the FY13 outlook) or at the very least, the start of near-term relative underperformance to other retailers in the coverage matrix (under the premise it's hard to justify further multiple expansion).
- Management has clearly planned inventory to support solid global growth, which is OK given the trends in the business at present. But that growth has to materialize and I have to ponder as an analyst if downside risk to Europe and volatile domestic spending conditions presents margin risk from this level of inventory planning. Basically, at current valuation is the market honestly thinking about downside margin risk?