2023-05-01 11:11:35 ET
Summary
- The company is still cheaply priced, but I see no catalysts for growth.
- Decreased sales with relatively high fixed costs could put pressure on margins.
- Inflation will continue to weigh on revenue growth in 1H 2023.
Introduction
Shares of Carter's ( CRI ) are down 7% YTD. I have previously written about the company and now I would like to update my forecast and share my expectations regarding the current and future operating and financial results of the business. So, after a few months, I would like to maintain my view of the company, as I still do not see growth drivers.
Investment thesis
At the moment, in my personal opinion, I still think that now is not the best time to go long, despite the fact that the company's shares continue to trade at a relatively low level. Firstly, I do not see growth drivers in the 1st half of 2023. Secondly, in line with macro expectations and management comments, inflation will continue to have a negative impact on consumers, which may have a negative impact on the financial results of the business.
Survey of 1Q23 and my expectations
The company's results were weaker than investors expected. The company's revenue decreased by 11% YoY. The decrease in revenue is largely due to pressure from macro factors, as high inflation continues to put pressure on the real disposable income of families with children, as a result, consumers reduce their spending. The operating margin fell to 8% as a result of lower gross margins and an increase in the share of SGA expenses due to reduced economies of scale because most of the costs are fixed. You can see the details in the charts below.
I would like to note that the results of the company are not a surprise for me, as management has repeatedly made statements in the past that the company expects pressure in the first half of 2023 from the demand side due to high inflation and the effect of deleverage.
I continue to stick to my “HOLD” recommendation for the company's shares, as in my previous article, as I do not expect a significant improvement in the company's macroeconomics, operating and financial performance in the first half of 2023.
At the moment, I expect demand and revenue pressures to continue into the next quarter, and I personally believe there will be continued pressure on the business' operating margins due to reduced economies of scale.
Although management is telling us that the company could show an improvement in gross margin due to a positive product mix and higher prices, in my personal opinion, the deleverage effect could have a negative impact on operating margins, which could lead to pressure on share prices and forecasts in 1st half of this year.
Drivers
Macro: Decreasing inflation, rising real incomes and growing consumer confidence could have a positive impact on consumer spending in the children's goods segment, which could have a positive impact on business revenue dynamics.
Prices: The company may raise prices for core products, however I don't think this driver will materialize in 1H 2023 as management previously raised prices in 4Q 2022.
Margin: Decreased freight costs and an efficient cost model could support operating margins and increase net income, which could push up the share price.
Risks
Margin: A decrease in revenue with a high proportion of fixed operating expenses (rent, salaries) may lead to a decrease in operating margin, which is a negative factor for the company's share prices. In addition, high inflation may contribute to an increase in the share of operating expenses, which may also affect the level of business profitability in the future.
Growth of promotional activity in the market: Increased marketing activity from competitors may lead to higher marketing costs and lower operating margins in the coming quarters.
Macro: In line with management commentary and macro forecasts, we will see continued high inflation in 1H 2023, which will continue to have a negative impact on consumer real income and spending in the baby products segment.
Valuation
According to the multiples, we see that the company is still valued cheaply. I would like to point out that the FWD P/E is higher than the TTM P/E, which indicates that the market is expecting lower earnings for the year. While I like the current valuation and business model, in my personal opinion, the lack of upside catalysts is negative for the potential revaluation and growth of the stock.
Valuation (Seeking Alpha)
Conclusion
I like the company's business model and current valuation; however, I would like to maintain my "HOLD" recommendation following the company's Q1 2023 results. In my personal opinion, company is currently unable to demonstrate a significant improvement in revenue growth rates, an increase in operating margins and a change in the product mix in favor of more marginal products. Thus, I believe that the catalysts for growth are currently missing. However, the stock is indeed undervalued by multiples and historical levels, which keeps me from recommending a "Sell".
For further details see:
Carter's: Still Not The Best Time To Buy