Shares of Carter's, Inc. (CRI - Free Report) have plunged 29.6% in a year compared to the industry’s 3.4% growth. The underperformance can be mainly attributed to softness 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 the performance of Carter’s U.S. Wholesale segment. In third-quarter 2018, sales at this segment decreased 8.3% year over year, owing to fall in shipments due to loss of sales to Toys “R” Us and Bon-Ton.
Moreover, Carter’s higher cost of investments toward technology, brand marketing and expedited shipping have been hurting 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. Going forward, this can be a threat to the company’s profitability.
Additionally, high inventory levels remain a worry for the company. 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. While management is working to normalize this equation, it expects net inventory growth to moderate to up 8% by the end of 2018.
Despite these potent limitations, we are optimistic about Carter’s Retail strategy that focuses on improving store productivity, strengthening e-commerce business and enhancing product offerings. The company’s Skip Hop and Age Up initiatives are likely to significantly drive retail sales growth in 2018. Additionally, the company is witnessing a positive response for its co-branded stores, which have been receiving maximum return on investment.
By 2022, Carter’s plans to open nearly 160 co-branded stores. Further, it 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 customer's experience and boost the company’s profitability.
Moreover, 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. In 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.
Meanwhile, Carter’s International business is witnessing solid growth, thanks to acquired licensee business in Mexico and robust demand in markets outside of North America. Further, the company is on track with the integration of the Mexico business, 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, Carter’s expects China to generate about $20 million sales in 2018, with significant e-commerce sales growth.
Despite dismal third-quarter 2018 results, management issued upbeat guidance for the fourth quarter. Carter’s expects net sales to grow 5% and adjusted earnings per share to rise roughly 10% year over year. In fact, the anticipated sales and earnings growth for the fourth quarter might be a partial recovery of the lost sales, which would have come from Toys “R” Us and Bon-Ton.
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.
For 2018, management anticipates sales increase of nearly 1.5% and adjusted earnings growth of about 5% from 2017 figure.
We believe Carter’s may spring back to growth in the near term backed by the aforementioned initiatives. An upbeat fourth-quarter and 2018 guidance also support our view.
Currently, Carter’s has a Zacks Rank #3 (Hold).
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