I’m adding CRI to our Best Idea short list. This is a great business – at least 50% of it is. Dominant in its core category, which is a high quality annuity. But it ends there. The the bridge between an eroding longer term EPS/Cash Flow growth algorithm and near term reality has tightened. Just because a part of its business is great it does not mean that the stock can’t be lousy, and I think it will be for the next 6-12 months.
The company is the master of the beat/guide down/beat game. But when the absolute organic growth algorithm is eroding so materially on the margin, I don’t care as much about the low bar. In addition, the ‘slam dunk’ guidance might hold for 2Q – in fact it likely will. But even if it beats its own forecast by 16% (our model), then earnings will still be down yy by 17%. Targets in the back half include a 50% recapture from Toys R Us – even though all 800 stores are closing. Growth sould be coming from International, but the company – in a very slick way, I might add – covertly took down growth expectations outside the US.
‘It’s cheap’ is the worst case to own anything in retail. And on the Street’s numbers it’s pseudo-not-expensive. But on our numbers it’s at a 17-18x pe, 11x EBITDA, and a sub-5% FCF yield when growth is slowing and margins and capital are under pressure. Leverage is not an issue here – so this is hardly a HBI-esque call (CRI has terminal equity value). But we have earnings relative to consensus down 6% for the year, -14% for 2019, and -23% in 2020. More importantly, we’re looking for a flat 2019, which the company has not done since a down year in 2011 (when it traded at 12x earnings), and is a major tell about the eroding growth and incremental margin implicit in this story.
So in the end, we’re looking for both earnings cuts and a subsequent re-rating. A 12-13x multiple gets us to a $75 stock, which is good for 25-30% downside. If the consensus is right (ie guidance holds for the year), then multiple upside to the current 18x is very tough to argue given the eroding return profile even if it hits numbers and guidance. 17x on an ‘earnings hit’ – which I think is a best case – is a $115 stock. That’s 11% upside from here – so the math work out to about 2.75 to 1 downside/upside.
More to come in a deck in the coming weeks.
Here’s McLean’s Overview of the Quarter
Revenue:
US Retail
- Comps slowed 150bps against a much easier compare. That made for a 500bps slowdown on the 2 year.
- Company citing that weather “offset a good portion of benefit from earlier Easter”, meaning the Easter benefit was more than weather hit… yet it still slowed significantly. There was also 10-20bps of help from half a quarter of acquired SkipHop that the company did not disclose.
- We see a 3% comp for the year aided by Skip Hop brand growth, and wholesale sales shifted to retail as part of rev recapture.
- Side note, 1Q18 represents the first net closing quarter in over 10 years.
US Wholesale
- The closing of BonTon and Toys R Us is $80mm in lost sales for the remainder of the year, or about an 6.5% hit to wholesale.
- 1Q was down 4%, with about 3 pts of help from Skip Hop, that doesn’t bode well for the updated guidance of down LSD after the lost wholesale doors.
- The company thinks it can recapture about half of the lost $80mm in sales. That rev recapture is easier when shifting the sales to CRI retail (though that would be mean its reported in a different segment then), but 50% still seems aggressive. We think best case recapture rates in situations like this are about 25%, but perhaps the Carter’s brand has enough draw and distro to do better.
- Either way, the wholesale guide now implies accelerating growth from 1Q, including the lost doors, on tougher compares. That is a high bar in our mind.
- The company expect wholesale partners will raise forecasts with CRI and purchase more in 2H to recapture the lost TOY sales. That’s at the time those partners will likely see slowing comps vs last year’s ramp.
- We’re modeling a 6% decline in US wholesale for the year.
International
- International growth slowed 90bps in c$ in 1Q to +15.7% in C$. This was with a very easy compare of -3.7% and with about 9pts of growth coming from the Mexico acquisition.
- The company is tempering growth expectations in this segment, targeting MSD growth in 2018, with China not going as well as planned and slowing store growth.
- The FX tailwind is waning at 30bps vs 50bps last Q.
- The launch of Skip Hop in Canada stores will be a small help to International segment growth (30-40bps) as well as the help from Mexico (4-5pts for the year)
- We think given the tailwinds of acquisition help and FX, the MSD bar is low. We’re modeling 10% growth for the year.
Margin:
- Gross margin was up 89bps, beating expectations by 50bps. Expansion was about the same as the 90bps increase last Q, though with an easier compare.
- Expansion was driven by lower product costs, mix shift to retail, and favorable FX.
- Mix shift to retail accounts for about 20-40bps of gross margin expansion for the year.
- With inventory building, and FX help going away, gross margin expansion should slow for the rest of the year despite the mix and product cost (a benefit through at least fall) help.
Cash Flow :
- Capex accelerating guided to $115mm vs $69mm last year to support store openings/remodels and ecommerce.
- Inventory building with whole door closures likely to cause increased inventory/margin risk.
