I think that CRI is losing control of its business, which seriously calls its forecast accuracy into question. As we look into 2019, management remains bullish about growth and profitability despite clear headwinds in its wholesale channel, and stalling share gain in retail as well as its core business. I was definitely pumped about the miss (only the second one in 33 quarters) and guide down given that we’re short the stock, but the reality is that there were some glaring inconsistencies in how management is planning its business vs current reality of retail. When all is said and done, I think that CRI is looking at a flat year in 2019 – which makes its ‘historical valuation range’ completely worthless. 2018 is likely to clock in a $6.10, and we’re not looking for it to grow off that number until 2022. Is the stock expensive today at 15x earnings and 10x EBITDA? Probably not. But this quarter should mark the start of a disappointing era of earnings for CRI that is likely to be revalued lower. Do I want to own this declining return business at a price? Not really. But if I did, it would be closer to 10x earnings – or about $60. Based on what I know today, I wont cover until this is a $75 stock (22% lower) – or 12-13x a sustainable earnings number. This event was not a kitchen sink. The Street’s gotta come down, and management doesn’t know it yet.
CRI Black Book Link: CLICK HERE
--McGough
Print Quick Take
- 7% EPS Miss at $1.61 vs $1.73, and with a 4Q guide down of 30 cents (10%).
- That is only the second miss in 33 quarters! The last one was 3Q16 (4% miss), and that came with a slight 4Q guide up, not the guide down we just saw.
- Revenue missed by 2%, gross margin missed by 60bps, leading to the first gross profit decline since 2011. Note, this is very bad as this company is mix shifting to retail, GP should just about always grow.
- US comps slowed 40bps to +0.5% on an easier compare. Ecommerce slowed significantly and stores were down 1%.
- 4Q guide implies a massive acceleration in revenue, to +5% from -2.6% this Q on a much more difficult compare, though the EPS number would then imply that gross margin is going to be down prob 100bps+. That could mean clearing product in retail doors to get the top line with a margin hit, which makes sense given the significantly bloated inventory position. The concern would then be how much does this hurt (pull forward) sales in early 2019.
- The question for us going forward is will the market price in the fact that 2019 will likely be a flat to down earnings year… it doesn’t appear that is happening today.
- CRI’s market share looks peaked, and top line growth is coming from mix shifting to retail and international, both of which are lower margin and lower return, meaning earnings not growing and multiple compression.
Callouts:
Lots of Misdirection from Management
- This was the most confusing call I can recall for CRI. The 3Q numbers and the guide were bad. Yet management sounded very promotional and we heard so many handpicked bullish callouts. It reminded me of HBI type data points like “core non-mass Champion was up 40%”.
We heard: - Co-branded stores continue to outperform comping up 6%, yet B&M comps were still negative and slowed on a 2 year basis as co-branded mix grows.
- TOY/BONT recapture is generally on plan yet sales are missing and wholesale is down 8%.
- 4Q sales are off to a great start, but 4Q was guided down due to revenue and not margin?
- The worst inventory position in 4 years is somehow planned, not a margin problem, and not due to distribution disruption?
- And why wasn’t management more clear about the margin impact of TOY early in the year? Half of those sales were supposed to be recaptured elsewhere, so why then does it matter that TOY was higher margin due to baby? Recaptured sales aren’t going to be in similar product mix? Why would that be the case?
- It feels to us management is losing some control of forecast accuracy and control over the business, which is concerning. Perhaps the retailer closings are the catalyst… Remember UA/TSA? (See slide below) Don’t underestimate the potential disruption of large customers shutting down doors.
Guidance Oddity
- The 4Q guidance makeup is odd. Revenue to accelerate to +5% from -2.6% on a much more difficult compare. Retail comps of 4% seem plausible given the Oct strength and the fact that the company will likely be clearing product in the channel in 4Q.
- However the wholesale guide of -3% for the year means 4Q would be up mid single digits, on top of +11% in 4Q last year. That appears very aggressive, especially given the wholesale door closure pressure, with SHLD likely being incremental to prior results.
- Then the company is signaling that wholesale will return to LSD growth in 2019 and beyond… door closures are not done for this channel, and other than price increases we don’t think wholesale has the ability to grow in the foreseeable future.
- Part of the 4Q weakness was credited to foreign currency impact on US ecom demand (international customers are ~25% of US ecom sales), that shouldn’t be going away anytime soon.
Does strong 4Q mean risk in 2019?
- The implied sales performance in 4Q, in the context of what appears to be weak gross margin, and planned inventory reductions signals to us that the company intends to force the sale of a lot of product in the quarter. That probably means real promotions and margin pressure. The question we then have is, to what extent is the planned ramp in sales in 4Q potentially pulling forward sales from 1H19.
- We were modeling a flat 2019 already, but if 4Q actually hits numbers, perhaps the risk rises for 2019 being down.
Weather and Q/Month Trend
- It is not surprising that October has started out strong. It is the easiest compare of 4Q from last year (+1.6% vs +5.5% for Nov/Dec), and the recent cold weather is supportive of capturing a majority of fall seasonal demand in Oct.
- Weather however does not support the weakness in 3Q since Labor Day was the issue and Labor day is not a cold weather selling period.
- Going forward, the company is facing tougher monthly compares as fall demand was likely concentrated in Oct.
2019 Guide?
- The company tried to imply that it's expecting “good sales and profitability growth” in 2019, without putting any real numbers behind it.
- EBIT should be down 6-12% this year, and we see many of the P&L pressures continuing in 2019. We think you’re looking at a flat 2019 for EPS or worse, and the market is not pricing that in.
- We’ll stay short here with 2 ways to win moving towards the 4Q result, we either see a miss and management credibility comes into question, or we see a hit and a guide down. We see the probability of a beat and guide up of 2019 as low given the fundamentals today.
