Carter's (CRI) - Tiny Clothes, Big Returns?
Carter's (CRI) is a retailer of children's apparel, the largest in the industry with a 12% overall market share, and a 140-year history. The company has two primary channels of distribution that contribute roughly equally to total sales. Carter's apparel is sold wholesale to over 4,000 department and chain stores, such as Macy's (M) or Kohl's (KSS). Special brand lines were developed for Walmart (WMT - the "Child of Mine" brand) and Target (TGT - "Just One You"), representing about 20% of sales. Additionally, Carter's operates 289 self-branded locations and an additional 175 OshKosh stores. OshKosh (acquired in 2005) is the firm's older age brand, while Carter's focuses more on newborn and infant clothing.
While several retailers occupy the Magic Formula screens at present, Carter's has some interesting characteristics that may make it a more attractive play than others. For one, children's clothing is a less volatile business than standard apparel. While adults will bargain shop in a recession, and teens are constantly changing fashion allegiances, parents and grandparents usually do not put as strict a lid on spending for the little ones, and fashion is a lesser concern. This helped the children's apparel market to a less severe decline in spending during the 2008-09 recession - a 3.5% decline vs. 5.1% in general apparel, according to NPD.
Demographic trends are also favorable. The U.S. is in a mini "baby boom" right now. More babies were born in 2007 than in any year in the country's history, and the 2000-2009 period was the highest decade for births since the 1950's, by far. Combine this with those 1950's births becoming grandparents, and the situation is ripe for organic growth in spending on children. Carter's is well-positioned to benefit. Same-store sales growth has consistently been in the mid-to-high single digits over the past several years.
On a operational level, Carter's has plenty of avenues for growth. With 464 stores, many analysts believe there is expansion potential to 600 or more locations. Consider that competitor Children's Place (PLCE) has over 950 stores, and Gymboree (GYMB) about 650, and the ultimate potential may be even higher. Growth should be attainable here.
Carter's also has solid financial characteristics. Cash and debt roughly balance out, at $245 million and $232 million, respectively. The company just pre-paid $100 million in debt back June, further strengthening their position. Operating margins after subtracting out one-time charges have been good in the 10-13% range. They have been particularly strong recently, with trailing twelve month margin at 15%. Free cash flow margins are 8-10%, high for a retailer, and return on capital is excellent at 20%.
There are some risks here. Several big chain retailers have been looking to move to private label clothing to improve their margins. Walmart's floor space reduction for Child of Mine has hurt, with the line posting a 47% sales decline in the most recent quarter. Carter's also posted its first same-store sales decline in three years for Q2, fueling concerns that competition such as Gymboree's Crazy 8 stores are hurting traffic. Finally, there seems to be some lingering concern over past management blunders. Carter's had to restate earnings last year due to accounting mis-steps, and also wrote down $155 million in goodwill from the purchase of OshKosh after continued poor performance. That is almost half the purchase price of $312 million, indicating significant overpayment.
Overall, though, Carter's looks like an attractive Magic Formula investment. At about $24, the stock's adjusted earnings yield (EBIT/EV) is 17.4%, well above its 5-year average of 10%. Taking into account 2011 projections, modest growth rates, and historical multiples, I believe a good sell price for the stock is about $35, a 46% increase from current trading levels.
Steve owns no position in any stocks discussed in this article.
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