Carter's, Nautilus: Retail Stocks That Almost Made The Cut

As I mentioned in an earlier article, I strongly considered featuring a certain company for my June investment newsletter, and even started writing about it, but ended up rejecting the idea at the last moment, deciding instead to feature Gymboree (GYMB). This company was Carter's Inc (CRI), the maker of baby clothes that is most likely to benefit from the "new baby boom" (an idea I discussed in the article about Gymboree).

Carter's, which has traditionally been a wholesales company, has diversified into retail with a two-pronged strategy that could bode well for the company. Carter's increased its retail exposure by acquiring OshKosh in July 2005 and by developing sub-brands called "Just One Year" and "Child of Mine" for Target (TGT) and Walmart (WMT) respectively. Debt levels have dropped when compared to last year; the company is buying back stock and reported better than expected results in the first quarter of 2007.

I cannot say I am thrilled by Carter's decision to buy OshKosh, as the OshKosh division seems to be losing market share to competitors like Children's Place (PLCE) and Gymboree (GYMB). This was evident from first quarter 2007 results where the Carter's division had revenue growth of 10.6% while revenue actually fell 0.2% at the OshKosh division. This compares with first quarter revenue growth of 12% at Children's Place (PLCE) and 12.6% at Gymboree (GYMB). They say that one quarter does not make a trend but this is the third consecutive quarter where year-over-year sales have fallen at OshKosh. Both retail and wholesale margins at OshKosh were also negative in Q1 2007. Given this trend of declining sales, I am baffled by management's plans to open 5 new OshKosh stores in 2007.

The $344 million in debt that Carter's carries on its balance sheet combined with declining sales in the OshKosh division made me take a closer look at competitor Gymboree for all the reasons mentioned here.

CRI 1-yr chart

Another stock I considered writing about was fitness equipment maker Nautilus (NLS). After lowering their first quarter and full year 2007 forecast and reporting terrible first quarter results, the stock has taken a bad beating in recent weeks. The major risk the company faces is the cooling of the red hot real estate market that has in turn dampened consumer enthusiasm for big ticket items like the Bowflex home gym and StairMaster products that Nautilus sells. This was cited as one of the primary reasons for net income dropping more than 50% in the first quarter. Given my negative outlook of the housing sector since late 2005, I have held back on adding Nautilus to the SINLetter model portfolio despite writing about it in the past.

With a dividend yield of 3%, a high short ratio of 12, a forward P/E of 11.26 and a forecast of 20 to 30% earnings growth in 2007, the company remains near the top of my watch list. The company has also started supplying fitness products to commercial gyms. In an interesting development, buyout firm Sun Capital recently increased its stake in Nautilus.

The key to Nautilus going forward is its Pearl Izumi and Nautilus branded apparel lines. I would like to see how sales growth in apparel shapes up before starting a position in Nautilus but given the bearish sentiment surrounding this stock, any small piece of good news is likely to cause it to go up in a hurry.

NLS 1-yr chart