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Carter's (CRI) Down 31% in a Year: Can Efforts Aid Recovery?

Zacks Equity Research

Carter's, Inc. CRI loses favor with investors, evident from its price performance in the past year. The stock has declined 31.2% against the industry’s 11.8% growth. Well, factors such as high inventory level, higher SG&A expenses and softness in its U.S. Wholesale business have been weighing on the company’s performance.

Nevertheless, Carter’s Retail strategy remains focused on improving store productivity, strengthening e-commerce business and enhancing product offerings. Further, the company is experiencing robust growth at its International business. Let’s take a closer look at both sides of the story.



Factors Behind Carter's Dismal Performance

Carter’s is witnessing sluggishness across its U.S. Wholesale business due to the bankruptcy of Toys “R” Us. The closure of Toys “R” Us stores, which is the company’s key wholesale customer, is largely weighing on its U.S. Wholesale segment’s performance. In third-quarter 2018, sales at this segment decreased 8.3% year over year on account of fall in shipments due to loss of sales to Toys “R” Us and Bon-Ton.

Additionally, higher cost of investments toward technology, brand marketing and expedited shipping have been denting operating margin. SG&A expenses, as a percentage of sales, increased 180 basis points (bps) in third-quarter 2018. This uptick was mainly driven by increased investments in new stores and e-commerce business, higher marketing spending, distribution, speedy deliveries and infrastructure. Consequently, operating margin contracted 220 bps in the third quarter. Moving ahead, this can be a threat to the company’s profitability.

Moreover, the company’s high inventory levels remain a worry. At the end of the third quarter, Carter’s saw a 14% increase in net inventories owing to the timing of inventory receipts and increased baby replenishment inventory.

Are Strategies Tracking Growth?

Carter’s Skip Hop and Age Up initiatives are likely to significantly drive retail sales growth. Additionally, the company is witnessing a positive response for its co-branded stores that have received maximum return on investment. By 2022, the company plans to open nearly 160 co-branded stores. It also targets increasing the mix of these stores to at least 50% of its store base compared with 20% at the beginning of 2017. Simultaneously, management intends to shut down roughly 115 less-productive stores, comprising mainly Carter's and OshKosh outlets. This is expected to improve the productivity as well as boost the customer's experience.

Further, Carter’s efforts to strengthen e-commerce capabilities through investments to speed up deliveries are impressive. Notably, the company has been witnessing double-digit growth in e-commerce sales, mainly backed by higher domestic demand. During 2019, it plans to launch the e-commerce capabilities in Mexico. Combined with wholesale, the company expects to reach $1 billion in online purchases of its brands in 2019.

Additionally, Carter’s International business is witnessing solid growth, thanks to acquired licensee business in Mexico and robust demand in markets outside of North America. The company is also on track with the integration of the Mexico business, acquired in 2017. It anticipates about $30 million sales contribution from Mexico, with the potential to double its sales in the next five years. Moreover, Carter’s expects China to generate about $20 million sales, with significant e-commerce sales growth.

Despite a dismal third-quarter 2018, management issued an encouraging view for the fourth quarter. It expects net sales to grow 5% and adjusted earnings per share to rise roughly 10% from the prior-year quarter number. Moreover, the company witnessed double-digit comparable-store sales growth initially in the fourth quarter driven by higher traffic, conversion rates and improved price realization. Management projects quarterly retail comps to increase approximately 4% backed by various strategic initiatives, including gains from Age Up size expansion and Skip Hop.

These tailwinds make us optimistic about this Zacks Rank #3 (Hold) stock’s return on the growth trajectory. However, the course and timing of the turnaround remain uncertain, keeping us on the sidelines at this time.

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