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Carter's (CRI) Retail Strategy on Track, High Costs a Woe

Zacks Equity Research

Carter's, Inc. CRI is gaining momentum on the back of its retail strategy that is focused on improving store productivity, strengthening e-commerce business and enhancing product offerings. Also, the company is experiencing robust growth in its International business.

Backed by these factors, Carter's delivered robust fourth-quarter 2018 results, wherein both the top and bottom line outpaced the Zacks Consensus Estimate and also increased on a year-over-year basis. Results were driven by growth in the U.S. Retail and U.S. Wholesale businesses during the final months of 2018, mirroring a strong holiday season.

In the past three months, shares of this Zacks Rank #3 (Hold) company have rallied 24.4% compared with the industry’s 27.7% growth.



However, the company is grappling with high inventory level and higher expenses. Moreover, closure of Toys “R” Us stores across the United States is largely weighing on Carter’s top line performance. Let’s take a closer look at both sides of the story.

Factors Driving Carter's Performance

Carter’s Retail strategy remains focused on improving store productivity and enhancing product offerings by introducing extended sizes for the Carter’s brand and expanding Skip Hop brand offerings. In 2019, the company anticipates net sales for Skip Hop to increase nearly 20% globally, contributing to total profitability. Additionally, the company is witnessing a positive response for its co-branded stores, which have been receiving maximum return on investment.

Carter’s also continues to experience robust growth in the International business as evident from the segment’s solid growth witnessed in 2018. Although the segment’s net sales declined in the fourth quarter, it improved 4% for 2018, contributing about 12.5% to the company’s total sales. This uptick was driven by the licensee business in Mexico and robust demand in markets outside of North America, partly offset by decrease in demand across China and the adverse impact of foreign currency. Notably, more than 60% of the company’s International sales come from Canada, which is likely to be the largest contributor to International growth in the next five years.

Moreover, the company is optimistic about the transition of its business model in China from a retail and wholesale model to a licensing model, with a single partner in this market. This new model is likely to enhance consumers’ experience with Carter’s brands and enable a more profitable growth strategy in China. The company estimates mid-single digit growth in international sales in the future.

Hurdles in Carter's Path

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, the company’s key wholesale customer, is largely weighing on its U.S. Wholesale segment’s performance. In fourth-quarter 2018, sales were adversely impacted due to the bankruptcies of Toys “R” Us and Bon-Ton. Additionally, the company’s high inventory levels remain a worry.

Moreover, higher cost of investments toward technology, brand marketing and expedited shipping have been denting operating margin. In the fourth quarter 2018, adjusted operating margin contracted 60 basis points due to higher e-commerce shipping costs and promotions, adverse impact of the Toys “R” Us bankruptcy, and increased mix of lower margin new businesses. Moving ahead, this can be a threat to the company’s profitability.

These apart, Carter’s outlined a soft outlook for the first quarter of 2019 due to difficult comparisons with the prior-year quarter. The company expects the top- and bottom-line comparisons for the first quarter to be negatively impacted by the loss of sales to Toys “R” Us and Bon-Ton stores as well as the shift of Easter holiday to second-quarter 2019 from first-quarter 2018. Also, net sales are anticipated to decline 4-5% compared with the first quarter of 2018. Adjusted earnings are projected to be 65-70 cents per share compared with $1.09 reported in the prior-year quarter.

While we cannot ignore these headwinds, the company's initiatives are likely to provide a significant cushion to the stock.

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