Carter's BlackBook this Friday at 10AM EDT.
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Confirmation Number: 13679936
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This Black Book will outline why we added CRI to our Best Idea Short list last week. Let's be clear up front about something -- this is a near-great business – at least 50% of it is. Dominant in its core category, which is a high quality annuity. Very good management, and killer brand. But 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. Downside/upside if our model for a 2H miss and flat '19 leaves us with 2.75 to 1 downside/upside.
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 750 stores are closing. Growth should 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.
