Picking Summer Infant (NASDAQ:SUMR) as a Top Idea in mid-October of 2013 has been a boneheaded move so far, as the stock has declined about 25%. Summer Infant's share price weakness has come in response to greater-than-expected struggles to migrate away from low-margin licensed business and reduce SKU counts.
With new management in place, Summer Infant is continuing its basic strategic decision to slim down and refocus itself around a smaller number of more profitable, more competitive SKUs. This is not an unusual or uncommon phase in prior growth-by-acquisition stories, but the process can be difficult and stretch on longer than investors' patience. Summer Infant has a long way to go before it is a more credible threat to Dorel Industries (OTCPK:DIIBF), Newell Rubbermaid's (NYSE:NWL) Graco, or Mattel's (NASDAQ:MAT) Fisher-Price, but Summer Infant doesn't have to become the best to be better.
Getting Smaller, But Not More Profitable
Summer Infant is still in the midst of a large-scale reduction in the number of products it sells. According to the company's own information, it went from 2,400 SKUs in January of 2012 to 1,100 in March of 2013, with further reductions in the time since. Summer Infant has also chosen to get out of low-margin licensed business with Disney (NYSE:DIS) and Carter's (NYSE:CRI).
The impact of these moves, as well as ongoing weakness at major retailer Toys R Us/Babies R Us, was a nearly 24% reduction in sales for the fourth quarter. While it is true that the juvenile/infant sector is not really growing well these days (Dorel's fourth quarter revenue declined almost 5%, though Newell's Baby & Parenting was up 4%), clearly Summer Infant is in a different situation right now as a result of these restructuring efforts.
Thus far the progress on better profitability has been mixed. Gross margin did improve about a point, but the operating loss increased slightly despite a 24% decline in core SG&A spending.
Looking For A Second Half Recovery
When Summer Infant released preliminary fourth quarter results in mid January of 2014, the company also announced significant management changes. Jason Macari, the founder of the company, stepped aside and the company named Carol Bramson, a long time private equity investor, as the new CEO. Summer Infant also appointed Ken Price, whose resume includes a similar role at Jakks Pacific, as the new President for Global Sales and Marketing.
Ms. Bramson has only been in the CEO position for a short time, but she was a board member prior to her appointment and she seems to be keeping the company on the same basic plan. She did note that the company's ongoing restructuring efforts are likely to lead to continuing weak quarterly numbers for the first half of 2014 before returning to growth in the second half of the year. Given the easier comps later this year and the overall direction of guidance, it doesn't sound like the second half rebound is going to be particularly strong.
A New Plan For Navigating A Tough Market
Birthrates tend to follow economic trends and it is probable that birthrates in North America are past a cyclical low that saw annual births fall below 4 million a year in the U.S.. That should help the underlying environment for Summer Infant, Dorel, and Newell Rubbermaid, though it is worth remembering that the improvement in birthrates is likely to be on the order of a few 100,000's (or around 5%).
Even if there are going to be more parents shopping for juvenile products, Summer Infant has to do more to stand out in the market. The company is very competitive in monitors (where it is a strong #2 to Dorel) and is also competitive in markets like bed rails and booster seats, but has a lot further to go to challenge Dorel, Newell Rubbermaid and Evenflo in car seats, strollers, walkers, safety, and feeding products.
The reason this matters is the changing nature of retailing. Retailers like Babies R Us and Wal-Mart (NYSE:WMT) are less and less likely to stock SKUs from three or four different manufacturers. Instead, they are likely to stock the leading and/or second-place brands and their own store-brand offerings. Producing products for the store brand or private label market is a low-margin business, so it becomes increasingly difficult to make money with an array of #3 or #4 products. Now this isn't as much of a problem in the world of online retailing, but that's not as big of a channel for this industry yet.
Modest Expectations May Still Be Too Much
While Summer Infant should return to growth later this year, full-year sales and cash flow are still likely to be lower than in 2013. Looking further down the road, I'm projecting long-term revenue growth of around 4% for Summer Infant, with a free cash flow growth rate a little below that as FCF margins normalize in the mid-single digits.
Those projections would support a fair value of $3 today even with a discount rate of 12%. Those low growth rates may sound conservative, but remember that Summer Infant is top three in only a small number of its addressed markets and it may well prove difficult to reverse this slide.
The Bottom Line
Summer Infant may have some value to Dorel, Newell Rubbermaid, or another player in the juvenile product market, but I expect such a deal would be more of a salvage operation and at lower levels than today's price. In addition to that DCF-based target of $3, an EV/EBITDA approach would support a fair value in the neighborhood of $2.50 to $2.75.
It's tempting to erase my notes on Summer Infant, delete it from my spreadsheets and forget I ever heard about the company. There is still a chance for a turnaround here, though, as the company does have solid products in areas like baby monitors and the company is pursuing a rational plan of shaving off unprofitable, uncompetitive product lines. It is going to take time for these moves to bear fruit, though, and no investor should consider these shares without having a lot of patience and a significant tolerance for risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.