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Carter's in Crossroads: Can Strategies Keep Hurdles at Bay?

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Carter’s Inc. (CRI - Free Report) is among the few stocks that are displaying mixed sentiments. We remain optimistic on the stock, given its solid surprise trend, robust outlook for 2018 and long-term strategies. However, softness in the company’s wholesale business due to the liquidation of its key wholesale customer, Toys “R” Us, keep us on the sidelines.

Evidently, the company’s shares have declined 9.9% year to date as the investor community remains concerned about the recovery of the company’s lost sales to Toys “R” Us. This reflects a significant underperformance from the industry’s 26% growth. Nonetheless, the company’s Retail strategy, along with solid e-commerce growth, and international expansion hold promise.

Let’s analyze the pros and cons of this Zacks Rank #3 (Hold) stock.

Strategies to Aid Growth

Carter’s Retail strategy remains focused on improving store productivity, strengthening e-commerce business and enhancing product offerings by introducing extended sizes for the Carter’s brand, and expanding Skip Hop brand offerings. The company’s Skip Hop and Age Up initiatives are likely to significantly drive retail sales in 2018. Further, the recent launch of Carter’s KID, a product assortment with over 700 styles for both boys and girls in sizes 4 to 14, is likely to reinforce the company’s position in the children’s apparel category and boost its Retail strategy.

Additionally, the company is witnessing a positive response for its co-branded stores, which is a one-stop shop for families with young children. These stores have been the most productive lately, receiving the highest promoter scores and return on investment. The company plans to open nearly 160 co-branded stores through 2022. Further, it targets increasing the mix of these stores to at least 50% of its store base compared with 20% at the start of 2017.

Further, the company continues to experience strong growth in its International business as evident from the segment’s solid growth in second-quarter 2018. Gains from this division are mostly driven by the Mexico acquisition and strength in Canada. 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, it is on track with the integration of the Mexico business, which was acquired in 2017. It anticipates about $30 million sales contribution from Mexico in 2018, with the potential to double its sales in the next five years. Moreover, the company expects China to generate about $20 million sales in 2018, with significant e-commerce sales growth through Tmall.

Carter’s is also seeking opportunities to strengthen e-commerce capabilities through investments to speed up deliveries. The company received a favorable response for its omni-channel capabilities rolled out in the last few years. Notably, its “Buy Online and Pick Up in Stores” capability and other initiatives aided retail sales growth in the second quarter. Also, Carter’s e-commerce sales improved in double digits in the same period. Combined with wholesale, the company expects to reach $1 billion in online purchases of its brands in 2019.

Bankruptcy of Toys “R” Us & Higher SG&A Remain Deterrents

The closure of Toys “R” Us stores across the country is largely weighing on Carter’s U.S. Wholesale segment’s performance that witnessed a sales decline of 3.8% in second-quarter 2018. Though the company expects to recapture lost sales to Toys “R” Us through its solid U.S. retail store presence of more than 18,000 in the long run, it anticipates the absence of planned sales to Toys “R” Us for 2018 to result in soft wholesale sales for the year.

For 2018, the company projects sales decline in a low-single-digit range for the Wholesale segment. Additionally, the company’s overall sales and earnings for the second quarter and 2018 are also likely to be hurt by the Toys “R” Us bankruptcy.

Furthermore, Carter’s has been extensively investing in initiatives to boost business growth, mostly for its e-commerce channel. The company continues to make investments in technology, brand marketing and expedited shipping to drive growth of its business segments. This has resulted in higher SG&A expenses, which have been weighing on operating margin growth.

Notably, adjusted SG&A expenses, as a percentage of sales, rose to 37.8% in second-quarter 2018 from 36% in the prior-year quarter. The increase was mainly driven by in-store and e-commerce business growth, higher marketing spending, and speedy deliveries as well as expenses related to the acquired Mexico business.

To reflect the increased operational and investment spending across businesses, adjusted operating margin contracted 130 basis points (bps), offsetting sourcing efficiencies and gross margin expansion. Management expects SG&A rate to be high as it continues investing in business growth and initiatives. This is likely to have a bearing on operating margin growth in 2018.

Bottom Line

Nonetheless, Carter’s ongoing Retail strategy and expansion initiatives provide visibility for the continuation of its positive surprise trend. Notably, the company has delivered an earnings beat in 17 of the last 18 quarters while sales surpassed estimates in nine of 11 quarters. This is further supported by its long-term earnings growth rate of 9.3% and a Value Score of B.

Looking for Attractive Picks? Check These

Some better-ranked stocks in the same industry are Rocky Brands Inc. (RCKY - Free Report) , with a Zacks Rank #1 (Strong Buy), Deckers Outdoor Corp. (DECK - Free Report) and Wolverine World Wide, Inc. (WWW - Free Report) , both carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Rocky Brands has pulled off an average positive earnings surprise of 56.3% in the last four quarters. The stock has surged 59.3% year to date.

Deckers has an impressive long-term earnings growth rate of 12%. It has delivered an average positive earnings surprise of 71.9% in the trailing four quarters.

Wolverine has long-term earnings growth rate of 10%. Further, the company’s earnings have outpaced the Zacks Consensus Estimate in each of the trailing four quarters, with an average beat of 17.8%.

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