Conclusion: Strength in Carters' wholesale drove the beat this quarter – and we’ll give them that, but that alone isn’t enough to support a stock with such lofty expectations. Importantly, with little delineation and differentiation of product by channel, stronger wholesale performance is actually competing against CRI’s own retail. In fact, this has been reflected by the decline in new store productivity. With Carter’s retail accounting for nearly 2/3 of 2H revenue growth and ~50% of CRI’s top-line in F13, the company is increasingly reliant on increasing the volume of less productive stores. It should come as no surprise then that store growth has continued to increase over each of the past two years at +14% and +17% in F11 and F12 respectively up from +10% in F10. This is simply not sustainable. Assuming CRI maintains this rate of growth, it would hit its ~600 store opportunity threshold by F14 – then what? We think it will have blown up it's wholesale business long before then -- there's your risk.
Lastly, the timing of management choosing to go dark on AUR disclosure for “competitive reasons” headed into 2H just smells bad. With product cost pressures now turning to a tailwind down -10% in 2H, the company will have to continue to post solid gross margin results for EPS to meet or exceed current guidance. The opacity in AUR disclosure does little to increase confidence in that regard.
All in, we’re reducing our 2H EPS numbers by $0.05 to $1.45 primarily reflecting higher SG&A spend (e-commerce and marketing) offsetting stronger trends at wholesale. At the time of writing this note, consensus was at $1.84 for 2H and $2.67 in F12 and $3.38 in F13. We’re at $2.40 and $2.95 respectively. If our estimates prove correct, this name has another 25-40% downside from these levels.
Accountability and Outlook: Here’s a look at CRI’s variance between guidance and actual, as well as the outlook for 2H vs. expectations:
Highlights from the Call:
Comp trends:
- +1% in each of the brands
- Carters:
- April: -3.4%
- May +2.2%
- June +3.9%
- Oshkosh:
- April: -1.9%
- May: +6.
- June: Roughly flat
- Expect a 2 point shift into Q1 primarily due to Easter shift and unseasonably warm temperatures
- Current comp trends tracking to plan
- Not seeing a traffic problem and of the 33 remodels to date, see sales upside due to traffic
AUR Trends:
- Pulling back on disclosure for competitive reasons
- "But we continue to make good progress on pricing"
Carter's Wholesale:
- No customers have seen any major issues with their business resulting in any shifts in demand
- 4 out of top 5 customers had growth in excess of 10% in 1H
- Continue to receive positive feedback
- Have moved Christmas up and could potential see goods in stores within a month
- Outlook for the business is good
2H Guidance:
- Didn’t feel the need to increase guidance every 3 months, but have a good growth plan in sales and earnings for the year
- First half was far better than envisioned
- 2Q is the least significant quarter of the year with 2/3 of profitability in the remainder of the year
- Contniued decline in off price sales will impact 2H wholesale results
E-commerce:
- Second full year of doing business online
- 1mm square foot DC just north of Atlanta
- Product is flowing in- wont be shipping out until later this year
- Margin benefit will be significant- pay a healthy premium to third party provider
- Carters e-commerce would reach near a 10% operating margin
Direct Sourcing:
- Previously worked with Li and Fung as a sourcing agent
- Goal is to be complete over a 5 yr timeframe
- Canada currently does direct sourcing and the margins are higher
- Have hired a very talented team over the past 5 years to head up the intiaitive
Product cost outlook:
- Outlook is good and continues to be good
- Fall cost for both brands are down about 10% after being up 20% last fall
- Still not back to normalized levels from 2 years ago
- Seeing visibility in spring 2013 which could be down 10%
- Level of clearance sales is down meaningfully which is benefitting margins
- Off price sales might be half of what they were last year
SG&A Outlook:
- Directionally, SG&A will rise as a percentage of sales
- As the business evolves the GM will improve but SG&A as a % of sales will increase
- Largely driven by Canadian ops, DTC, e-commerce, etc.
Channel Acquisition:
- Establishing a sourcing team in Hong Kong to support international partners
- Opening a third party logistics center in Hong Kong
- Now product will go from Asia to Hong Kong without going to Georgia first
- Earning impact is immaterial
OshKosh:
- Girls product offering is working which had been the weaker component over the years
- Gender split is 50/50 for OshKosh; girls is currently running at a slightly higher percentage with girls outperforming
Gross Margin:
- Majority of upside was driven by Carter's business
- Child of mine has been a good margin performer
- Started to ship fall product and costs are down about 10%
- Inventory position is dramatically better than a year ago
- Will continue to see a mix shift benefit
- At wholesale, customers are focused on maintaining strong pricing via product offering, brand presentation and ease of shopping
Canadian Comps:
- Cobranded comps +5%, nameplate comps -12%
- Experienced a significant pull forward in demand into Q1
- Overall first half was down about 1.5% due largely to outerwear and warmer weather
Pricing:
- Planning for pricing to be flattish in 2H
- Spring 2013 pricing will be similar to Spring 2012 pricing
14% pretax margin goal:
- Current business is much different relative to 2010
- Expect it will take 4 or 5 years to get back there
Bookings:
- OshKosh bookings ex off price down slightly
Transactions:
- Down slightly in the quarter
- But the quality was more significant
- Conversion is up at record highs
OshKosh Mall initiative:
- Looking for the best real estate- not avoiding malls where product is already being sold
