Carter's: Unreasonably Undervalued
Summary
- Carter's is currently undervalued at a share price of $81.39.
- Carter's Age Up Strategy has allowed the company to expand beyond the babies and children market.
- The company has begun expanding internationally through the use of partnerships.
Investment Thesis
I believe that Carter's Inc. (NYSE: CRI) is currently undervalued due to both an overreaction towards the Toys "R" Us Bankruptcy and an underestimate in the growth of Carter’s from international expansion and partnerships with firms such as Amazon (AMZN). Combined with the launch of its new “Age Up” program, Carter’s is positioned to acquire an older client group while also recapturing lost sales.
Company Overview
Carter’s Inc. is the largest brand marketer in North America for apparel exclusively for babies and young children. Carter’s has three separate apparel brands – Carter’s, OshKosh, and Skip Hop. As of 2017, Carter’s owns and operates more than 1,000 retail stores in North America and has over 17,000 wholesale locations in the U.S. The company has recently started developing its e-commerce site in North America and China.
Carter’s Business Segment Revenue is as follows: 36% U.S Wholesale, 52% U.S Retail, and 12% International. The company’s main channels include Costco (COST), J.C. Penney (JCP), Kohl’s (KSS), Macy’s (M), Amazon, Target (TGT), Walmart (WMT), and Toys "R" Us.
Industry Overview
The baby and young children’s apparel and accessories industry is highly competitive. Baby clothing refers to clothing that is designed for kids younger than 36 months. Key Factors in assessing the competition are brand name recognition, product quality, price, selection, and convenience. Regarding quality, there's further segmentation into materials (i.e. cotton, wool, and silk) The market's greatest driver is the demand for branded apparel in the general population, and Carter's has the largest brand presence. Other key players in this industry include Disney, Old Navy, and The Children’s Place.
Catalysts
Carter’s recently introduced its new “Age Up” Strategy that will add Carter’s Brand Goods up until the age of 10. This is the company’s move to slowly expand outside the baby and children’s space. As branding power generally decreases when buying clothes for older children, this means that Carter's has a chance at penetrating the older children apparel marketplace.
The company will increase its growth through partnerships domestically with Amazon for its online Simple Joys brand and internationally with China’s Pou Sheng. This will allows the company to increase sales both domestically and abroad, also increasing the company's already existing brand presence.
The company received its Mexican Licensee in August 2017, which is an opportunity to expand the brand’s presence in the southern portion of North America. As Carter's continues to remain the leading baby brand in North America, it will be able to maintain this position through exposure in the south.
Risks And Mitigants
One possible risk is an unexpected decline in Global Consumer Spending; however, this is unlikely given current trends and decreasing gas prices.
Companies such as Disney (DIS) have been increasing their market share, which means that there could be heightened competition in the kids' apparel industry. But, Carter’s currently holds the most market share in the space, and brand name recognition is a big factor when it comes to what customers buy for their children.
As mentioned before, the quality of products influences what a buyer purchases. Given increased competition, input costs could increase in the future to produce higher quality goods.
Valuation
Assumptions:
Effective Tax Rate of 23%. The current tax rate as stated by management in the recent quarter conference is 22.6%, and the projections depicted are based on constant Tax Rate.
A Long-Term Growth Rate of 3% is used as a safe indicator based on the Unlevered Free Cash Flow
An EBITDA Multiple of 9x is used due to an assumption of a small decline from the Toys "R" Us Bankruptcy. The current EV/EBITDA is 10.44.
(Values in Millions)
| Carter's Unlevered Free Cash Flows | ||||||
| Period (T) | 2017A | 2018P | 2019P | 2020P | 2021P | 2022P |
| EBITDA | 530 | 554 | 588 | 633 | 721 | 771 |
| EBIT | 446 | 464 | 492 | 526 | 607 | 650 |
| Tax Rate | 23% | 23% | 23% | 23% | 23% | 23% |
| EBIT (1-t) | 446 | 359 | 381 | 408 | 470 | 503 |
| D&A | 84 | 90 | 96 | 106 | 114 | 122 |
| Increase in NWC | 90 | 4 | (3) | 34 | (2) | (46) |
| Capital Expenditures | (46) | (83) | (183) | (104) | (104) | (89) |
| Unlevered Free Cash Flows (UFCF) | 575 | 370 | 291 | 444 | 478 | 490 |
| Discount Rate (R) | 10% | 10% | 10% | 10% | 10% | |
| PV of UFCFs | 337 | 240 | 334 | 327 | 304 |
| Terminal Value - EBITDA Multiple Approach | ||
| EBITDA Multiple | 9.0x | |
| Terminal Value in 2022 | 6,941 | |
| Stage 2: PV of TV | 4,310 | |
| Enterprise Value (Stage 1 + 2) | 5,851 | |
(Source: 10-K)
This results in a final share price of $112.76.
Conclusion:
Based on this Discounted Cash Flow Valuation using the EBITDA Multiple Approach, the calculated final share price of Carter's is much greater than the current price of $81.39. Carter's strong brand and marketing presence combined with its growing international presence have positioned the company for long-term growth.
This article was written by
Disclosure: I/we 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.