Back in April I wrote an article outlining my bull thesis for Carter's, Inc. (NYSE:CRI) and, while many retailers have been crushed this year the stock has steadily climbed higher in recent months. But CRI fell more than 11% Wednesday after the company reported second-quarter earnings, and we don't think the sell-off makes sense. CRI beat estimates on the top line and bottom line, but management lowered guidance: the company now expects full-year revenue growth of 5-6% and EPS growth of 10%, compared to the prior forecast of 6-7% growth and 10-12% growth. The downward revisions are minor and won't matter in the broad scheme of things. We think Carter's is a compelling choice for long-term investors at these levels.
Carter's is the world's largest marketer of branded apparel for babies and young children. The company's Carter's and OshKosh brands are recognized globally as the standard in infant apparel. Carter's has just about everything you look for in a long-term investment: secular but stable growth prospects, a durable competitive advantage and shareholder-friendly management. Population growth (especially in China) will underpin demand for years to come, and we think some important demographic shifts will benefit Carter's premium-branded products. More and more women are putting off having children until they establish their careers, leading to higher average incomes at childbirth and more money to spend on high-end labels. In addition, the proportion of generation-Y parents in the market will continue to grow. Studies show that this demographic emphasizes quality and brand more than other groups. Carter's has grown revenues at a 5-year CAGR of 11.5%, and by expanding into e-commerce, the company eliminated the biggest threat to its business. Direct to consumer channels will account for the bulk of CRI's growth going forward.
Despite investing more in store expansion, technology, marketing and the China e-commerce platform, CRI has managed to grow margins and returns on capital over the past five years. This is no easy feat, and it's a testament to the company's formidable competitive position. CRI has pricing power, thanks to its strong brand and reputation for quality. Customers are loyal and we think rivals will need to dramatically increase spending in order to take share from CRI. The company's longstanding customer relationships raise barriers to success by limiting access to distribution. Retailers and wholesalers allocate shelf space based on reputation and market share, and Carter's is the number one player with approximately 15% share.
Figure 1: Growth, Profitability and Returns
Carter's is less risky than most apparel stocks. Baby clothing is more of a necessity than a discretionary item whose demand fluctuates with income, and the products are less exposed to changing consumer preferences. Baby apparel doesn't really follow trends or fads, and demand is relatively stable and predictable. Management has invested wisely, making key adjustments to the business (such as building an e-commerce platform) without over-extending itself through value-destroying acquisitions. CRI is committed to returning capital to shareholders and the company has $380 million remaining for share repurchases this year. This will provide some support to the stock price and we don't think shares can fall much further this year.
Carter's was down more than 11% Wednesday but it's just a bunch of noise. Management only lowered its guidance by 100 basis points and the long-term thesis remains intact. Through pricing and e-commerce, CRI continues to deliver strong comps and China could be a massive opportunity. There is little value to be found in today's market, but CRI is one option.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CRI over 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.