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MagicDiligence (< 20)

Magic Formula Stock Review: Gymboree (GYMB)



June 03, 2010 – Comments (0) | RELATED TICKERS: GYMB.DL , CRI , PLCE

Gymboree (GYMB) is a children's clothing retailer, primarily in the United States (less than 5% of sales are outside the country). The company has 3 store concepts. The namesake Gymboree stores have 629 locations as of January, with 593 in the U.S., 34 in Canada, and 2 in Puerto Rico. Gymboree stores represent a "middle-of-the-road" price point. Sandwiching Gymboree is the firm's other two concepts - the high-end (Janie and Jack, 119 U.S. locations), and the recently launched lower-price chain (Crazy 8, 65 U.S. locations). Gymboree also runs 139 outlet stores. Janie and Jack stores usually carry apparel at about 40% higher prices than Gymboree, while Crazy 8 is priced 25-35% lower.

Clothing retail is a very easy business to understand, so let's get right into an examination of the core aspects of the company as an investment candidate - growth potential, competitive positioning, and financial health.

First, growth. Most of Gymboree's near-term growth is going to be driven by opening new Crazy 8 stores. This concept has performed well through the consumer downturn of 2008-09, and has a large addressable market which management estimates at over 500 stores in the U.S. Gymboree is planning to open about 100 new Crazy 8's in 2010, doubling their initial plans. This should provide strong top-line performance, although gross margin may suffer due to the lower pricing. That said, this hasn't been apparent yet. Gymboree's trailing 12-month gross margin of 48.3% is actually well above the 5-year average of 47.2%.

There are other growth catalysts as well. The firm as a whole averaged 6% annual same-store sales growth, although this has slowed significantly over the past 2 years. As the consumer rebounds, I expect better performance from the Janie and Jack stores as well. Longer-term, there is potential for international expansion. And a focus over the past 2 years on improving operations has raised operating margin from under 10% in 2006 to about 17%. All-told, I see no reason that Gymboree cannot deliver 8-10% annual growth over the next several years.

Probably the largest risk is the intense competitive environment in children's clothing. Gymboree has several direct competitors, including Children's Place (PLCE), Carter's (CRI), and GapKids/BabyGap (GPS). Department stores like Target (TGT) and Walmart (WMT) compete directly on the low end with Crazy 8. Other specialty retailers have been entering this profitable niche, such as American Eagle's (AEO) 77kids, which was launched in 2008. With so much competition, everything becomes more difficult. It becomes harder to secure good locations at favorable prices, harder to win a higher dollar share of Mom's wallet, more expensive and difficult to market successfully, etc. And, of course, with so many competitors, there is intense pricing pressure, particularly if one or more competitors decides to make a market share grab and get overly promotional. The business has no moat and will always face competitive risks. Gymboree has no dominant position here.

Financial health is of no concern. Gymboree has a great balance sheet with $271 million in cash and no debt. Efficiency is excellent. The company's operating margin of 17% is well above competitors, and standard returns on capital have averaged a very strong 34% (MFI-adjusted return on capital is over 60%). Free cash flows have been good as well, averaging over 11% of sales through the past 5 years. This is all good news, although most publicly traded specialty retailers sport similarly solid financial metrics. Gymboree does not pay a dividend, unlike some of its competitors.

So, is Gymboree a good buy? The current earnings yield is about 17%, which is cheap, but this stock has never really commanded a very high valuation (the 5-year average earnings yield is just 12.6%). Still, the sell-off after Q2 guidance disappointed was certainly overdone - the stock traded at $55 a little over a month ago. MagicDiligence believes a reasonable one-year target price for Gymboree is about $65, about a 25% premium to the current price. That is an acceptable margin of safety to buy.

Gymboree doesn't quite make the Top Buys list though. Specialty retail is so competitive, and its history is littered with companies that looked great, performed great, and then made a few mis-steps that buried them (PacSun (PSUN) comes to mind). MagicDiligence prefers a more significant margin of safety, or an attractive dividend before recommending a stock in this sector.

Steve owns no position in any stocks discussed in this article.

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