The Consumer Stock Network

Investment recommendation: The investment strategy for Carter's (NYSE: CRI) stock depends on your vantage point. On one hand, baby and children's apparel are a consumer staple, and the Carter's/OshKosh brands certainly resonate with mothers everywhere. Sales should remain healthy even in a challenging environment. On the other hand, OshKosh's return to profitability remains a work and progress, and the market will not reward the stock with a mid-teen earnings multiple until there are more concrete signs of margin improvement. Our advice: take a pass on this stock for now, but keep it on your radar screen for possible buying points towards the end of the year.

Key considerations:

• "I think its reasonable to assume that earnings this year could be down 5% or more." Sometimes earnings conference calls boil down to a single comment. This line, spoken by CFO Mike Casey during the guidance portion of this morning's conference call, pretty much sums up the situation at Carter's. Citing general consumer weakness and OshKosh's sluggish performance, management now believes that its full-year earnings could fall 5% below last year's adjusted $1.43 figure (or roughly $1.36 per share). Applying the low double-digit earnings multiple that we mentioned in our preview (let's assume 10x, in-line with last year's operating margins), we arrive at a price of about $13.60, which is where we find the stock trading midway through today's session.
• Re-examining the business model. Management discussed 5 components to make its business model more competitive, which were (1) product leadership via design and development; (2) price cuts, including 8%-10% reductions at Carter's and 10%-15% at OshKosh; (3) more effective branding efforts, including additional shop-within-shops at Kohl's (NYSE: KSS), Macy's (NYSE: M), and JC Penney (NYSE: JCP); (4) increasing wholesale customer profits; (5) increased inventory turnover via new POS systems and planning/allocating tools. Though these goals are admirable, we still question whether or not any progress can be shown in today's environment. Perhaps the most troubling of these components are price cuts mixed with improved wholesale customer profitability, which will likely drag on top and bottom line results unless product velocity materially improves. Although management concedes that these measures will likely have a negative impact on margins through 4Q08, we have concerns it may take until 2009 to fully realize the benefits.
• OshKosh, my gosh. Though the OshKosh brand appears better positioned compared to two years ago, profitability remains elusive. Every time it appears the segment has turned the quarter, operating margins seem to disappoint. There weren't as many calls for a strategic sale of OshKosh business as there were on the 4Q07 conference call, but shareholder patience remains low. We do not expect the stock to show meaningful gains until there is evidence that OshKosh can grow and sustain acceptable low-to-mid teen operating margins.
  
• Earnings and guidance analysis. In a nutshell, the sales outlook is bright, but earnings are less visible. The implied full-year EPS guidance of $1.36 seems reasonable, but gives the company an achievable target if the aforementioned business model changes are effective. However, markdown activity and wholesale customer provisions will likely continue to eat away at margins for the near-term. Retail sales should remain strong at the Carter's brand throughout the coming months, spurred by the season change, easy year-over-year comparisons, and the arrival of federal stimulus checks. Look for high single-digit/low double-digit comps in 2Q08, with a moderation in the back half. Carter's wholesale sales growth will likely remain in the mid-single digits for the foreseeable future, based on booking trends. OshKosh retail trends are much more difficult to predict, but easing comparisons should at least help the company "improve meaningfully" as it discussed on the call. Mass-channel sales should improve steadily throughout the year.