CRI wins the award for the most disappointing EPS report yet. Really…there’s not much on the positive side to pull out at all. Yeah, the company missed and guided down. But it’s the speed of and derivation from which things changed is the bigger callout for me.
Consider this…
1) Every division experienced sequential erosion in underlying top line trends.
2) The most pronounced was in CRI’s mass business. Though Mass is CRI’s lowest margin business, it is the highest ROI by a moonshot. Revenue rolled in this space by about 1500bp, and CRI noted that it was almost entirely driven by loss in shelf space at Wal*Mart. So let me get this straight, WMT’s apparel business is in disarray, they fire their head of apparel, and simultaneously cut space from CRI. Perhaps unrelated, but I certainly wouldn’t want to be the head of the Mass business at Carter’s now.
3) Carter’s posted the sharpest sequential erosion in its trajectory on our SIGMA chart out of any company to report this EPS season. See chart below. The punchline there is that inventories are building relative to sales at the same time the company is about to go up against its biggest gross margin gains in years.
4) CRI’s guidance suggests an acceleration in top line throughout the remainder of 2010, yet 2H earnings better than 20%. Yeah, I know that labor, commodity and import costs are up. No escaping that. But do you think that just maybe they can slow down their growth a bit and gain control of their business? Instead they’re budgeting costs up 10% in 1H (enough?), and are banking on raising prices in certain areas to offset these costs. Do you want to bank on that? I don’t. Hey CRI, stop adding stores, and get the product org in order. Note to management: even big retailers in disarray rarely cut great product.
5) No one should forget that this company is operating at peak margins of around 13%. Even during the years where CRI struggled leading into and out of its well-deserved management shake-up, it never got below a 9% margin. Then it raced up from there printing what I’d consider an unrealistic revenue flow through rate from wholesale restocking and commodity cost relief.
6) Also, remember that it’s ills last go around were based on the fact this has traditionally been the ultimate ‘baby basics’ play. The brand is extraordinarily defendable in that segment, but unfortunately, growth has been coming from playwear (competing with the Old Navy’s of the world), mass channels, and company retail – all of which are inherently more volatile that CRI’s core. Unfortunately, the company has not yet invested in the infrastructure needed to sustain the top line in those businesses when faced with anything other than a bullish consumer tape.
7) The company guided to down gross margins in 1H next year – without further clarification or quantification. That’s fine, and in fact I would not expect the company to know what Gross Margins will be given factors above. But a warning to those financial modelers out there…don’t think ‘down’ in terms of 40, 80, or even 100bp. This could be much more. Just ask Li&Fung.
8) Bottom line: yes, 2011 should be a down year. If the consensus does not come out with such numbers after the conf call, then despite trading down today, this name is likely to have additional downside.
