|Shares Out. (in M):||22||P/E||15.2x||11.7x|
|Market Cap (in M):||1,054||P/FCF||21x||16.7x|
|Net Debt (in M):||-195||EBIT||103||128|
While Children’s Place (“PLCE”) may appear like just another retailer struggling with a weak consumer and online competition, PLCE has numerous self-help initiatives that will increase its productivity and growth over the next year or two. In addition PLCE may also see macro secular tailwinds driving further revenue growth for years to come. Trading at a mere 4.5X 2015 estimated EBITDA with about 20% of its market cap in net cash, PLCE appears to be an attractive risk reward that could trade 45% higher.
DESCRIPTION AND BACKGROUND
PLCE is the largest children’s specialty retailer in North America. They sell apparel, accessories and footwear for children sizes 0-14. PLCE designs, contracts to manufacture, and licenses to sell fashionable, high-quality, value-priced merchandise, the majority of which is under the proprietary “The Children's Place”, "Place" and "Baby Place" brand names. The Children's Place store has differentiated departments and serves the wardrobe needs of Girls and Boys (sizes 4-14), Baby Girls and Boys (sizes 6 mos.-5T) and Newborn (sizes 0-18 mos.). PLCE also sells online at www.childrensplace.com..
The Children's Place was founded in 1969. As of last quarter, PLCE operated 1,106 stores throughout North America. PLCE competes with many retailers who sell clothing for children and babies. Included in the list are Carters, Gymboree, JC Penney, Old Navy, Walmart, the Gap and Target. Of this list, the closest comparable is Carters and Gymboree (private) who are specialize in children’s clothing. PLCE stores are primarily located in the United States and about 10% of their stores are in Canada. Furthermore, PLCE is expanding in other International locations such as the Middle East and Latin America through franchise agreements.
MACRO AND COMPETITIVE ENVIRONMENT
There have been significant macro and competitive headwinds facing PLCE over the last several years and some of these headwinds may be coming to an end, and in turn provide a tailwind moving forward.
Birth Rate. Since the financial crisis of 2008/2009 the births in the United States has dropped from 4.3 million in 2007 to 3.9 million in 2013. There was a steep drop in births from 2008-2010 and then the rate of decline slowed from 2010 to 2012 and is essentially flat from 2012 to 2013. The reason for this large drop has largely to do with the financial crisis in 2008. Starting a family is usually done when there is some confidence in the the job market and the economy. As the economy has stabilized over the past few years (e.g. in housing), some economists believe the rate of births has leveled off and/or is in a process of growing again to normalized levels. This population backdrop since 2009 has served as a significant headwind for PLCE as their addressable market has shrunk. However as the birth rate stabilizes or grows this headwind may become a tailwind for years to come.
Competitive Environment. The competitive environment for PLCE has also increased over the years as big box retailers such as Target or Walmart that sought after a larger share of children’s clothing. In addition many other retailers continued to open stores in North America. ThisIn addition, the popularity of purchasing clothing online has also increased which puts pressure on PLCE retail locations. This competitive environment has caused significant financial damage to other competitors such as Gymboree.
While PLCE would certainly benefit from any turn in the macro or competitive environment in my opinion, PLCE does not need to rely on such factors to significantly improve its business. As described below, PLCE has numerous inititiatives that: 1) Improves Operations and 2) provides Revenue Growth.
PLCE has a few initiatives in place to improve current operations that don’t require significant investment or a rebound in sales or the economy. These initiatives are already in motion and do not require signficant (if any) charges or higher expenses to execute. These initiatives are likely to have a positive impact regardless of macro environment.
PLCE has been using the same outdated ERP for the last 20 years and this year it has just completed an upgrade to SAP. PLCE began planning for the upgrade in 2013 and has allocated signficant resources in planning for the implementation. PLCE will have invested $35 million on the ERP system. The company assigned 50 people from the company to assist with this project and they will be adding additional functionality throughout this year to benefit 2015. PLCE expects SAP to help enhance assortment planning, localization, pricing, replenishment and inventory replenishment. PLCE successfully installed SAP last quarter which will assist in managing the inventory and purchasing processes. In the past, PLCE would have to manually process and generate purchase orders which was very inefficient. The old process was prohibitive in PLCE adding wholesale and franchise partnerships which is a key to growth. PLCE plans to further invest in upgrades this year to be in place by the 3rd and 4th quarter. PLCE will implement assortment planning which will help maximize sales and minimize markdowns. Right now PLCE only segments its stores into two segments: warm and cold climates. SAP will help PLCE identify at the individual store level what products are best suited for each store. The more PLCE can tailor its products to the store level the more likely sell-through will improve. Another item that will benefit PLCE is price optimization. For example, in the old system, if the company took a markdown in a particular item, it had to take the markdown in all stores. If bathing suits were not selling well in the New York, and they marked down the suits, PLCE would have to mark down the same product in Florida. This makes no sense and the new ERP price optimization is likely to increase gross margin for the company.
Management plans to close 125 underperforming stores through fiscal year 2016. Many of these stores are operating at a loss and all of the stores are operating below the average productivity of the entire fleet. By closing these stores, PLCE will be able to increase operating margin while still mantaining a significant portion of revenues. Historically, PLCE has been able to capture 20-30% of sales from a closed store which migrates to another nearby store. If PLCE can effectively capture sales by migrating customers to another nearby store or online, the store rationalization can increase operating margin by about 25 basis points.
REVENUE GROWTH OPPORTUNITIES
PLCE has numerous growth initiatives which carry higher operating margins that may be significant to the bottom line. Some of these have not hit the income statement yet but may as time goes on.
There has been a strong trend in more children’s clothes being purchased online and PLCE is positioning itself to take advantage of it. Some of the reasons why children’s clothes sell well online is that the clothes are not high fashion where a customer needs to see the material in person and try it on. In addition, the fit of the clothes do not necessarily need to be perfect. Often parents purchase clothes that are a size above so the child will get good use out of it. Also, the purchase price of children’s clothes particularly at PLCE are so low (e.g. shirts at $5-10) that parents feel like they are not risking much in buying something they haven’t seen in person. Parents like to opportunistically buy inexpensive clothes and accessories for their children. Zulily (ticker symbol ZU) is an example of a company that caters to Moms who want to take advantage of flash sales of overstock merchandise. ZU is growing revenue at about 40%. Last year PLCE grew its online revenue about 20% and it now represents about 14% of the total sales. PLCE has been catching up PLCE continues to enhance the user experience at the website. They recently upgraded the platform and launched a mobile optimized site and mobile apps which should encourage more sales over the internet. The online site offers expanded sizes and exclusive products and offerings that you cannot find in the store. It is believed that customers who purchase online are a different demographic (e.g. have higher income, working mothers) than those shopping in the stores which generally have lower income. Due to the differentiation of product breadth and assortment, and demographics of customers who purchase online, it is less likely that growth in e-commerce cannibalizes store sales. PLCE recently refreshed its mobile website which when combined with the ERP system allows PLCE to execute on an omni-channel strategy. PLCE can use the updated ERP system and mobile website in tandem to market to its loyalty customers. Statistics show that PLCE loyalty members and online customers purchase around 2X a retail only customer.
PLCE is pursuing large retailers as potential wholesale partners. In these relationships, PLCE would manufacture and sell Children's Place branded products into their stores. Examples of such partners are Sam's Club and TJ Max. Currently, revenue from wholesale is neglible but could be $100 million plus over time. Right now, PLCE is testing with retail partners and if tests prove successful, these customers will roll out PLCE products to all its locations. Over time, PLCE has the opportunity to add additional wholesale partners and PLCE's products might have the potential to be found in over 7,000 locations across the country. It is worth noting that Carter's generates over $1 billion of sales annually from the wholesale channel in addition to its retail locations. While PLCE is no Carter's, a mere fraction of this amount would be material to PLCE. PLCE now has the ability to go to the same wholesale partners as Carters and offer a competing product. Sales into the wholesale channel would carry a lower gross margin but a higher operating margin. While the impact of the wholesale initiative is likely minimal in 2014, it may significantly add to revenues in 2015. Sales into wholesale partners would help broaden its consumer base. Additional retail partners may include companies such as Costco, Target, Walmart, Ross etc. In the intermediate term, PLCE could add $35-40mm of sales if successful which would mean another 10-15 cents in earnings. Also importantly, these earnings come with minimal capital investment. The investment of SAP ERP has also opened up the possibility for PLCE to sell its product through other ecommerce partners such as Zulily and other e-commerce sites where it currently does not sell its products.
Starting last year PLCE began partnering with international franchisees to open Children's Place stores in the Middle East. At the beginning of this year, PLCE had 35 franchise locations and is planning to almost double that number by the end of this year to 75 locations. The company just announced that it would be expanding its franchise program into Latin America and the Carribean. This capital light version of opening new stores offers higher operating margins than company owned stores and lower capex. PLCE makes profits from these franchise locations by selling merchandise wholesale to these franchisees and receiving royalty income based on revenues. It is estimated that the international locations do about $1mm in annual revenue and we estimated that PLCE recognizes about 25% of those sales in the form of product sales and royalties.
FINANCIALS (In Millions, Fiscal Years ended January 31)
|Free Cash Flow||67||49||63|
As mentioned above, PLCE will try to offset the brutal retail environment with efficiency initiatives through its new ERP system and revenue growth opportunities in International and wholesale. 2015 modeled above shows an enormous jump in earnings with an increase of $30 million in topline growth of just 1.6%. As shown above, $30mm of sales can be generated by the International and Wholesale initiatives alone which carry higher operating margins according to management. In addition, e-commerce which is growing 15% also carries a higher operating margin contribution. The ERP system is also expected to have a positive impact to margins. For all these reasons, 2015 may see a significant rebound in operating margins despite a flattish overall topline.
The primary risks with investing in PLCE is the macro environment, weather, further decline in birth rates, stiff competition from big box retailers, significant increases in cotton prices and further declines in mall traffic. There is also fashion risk and operational risks relating to manufacturing and supply chain logistics.
PLCE is a highly shorted stock and its valuation is depressed. Some of the factors that contribute to its negative perception are that gross margin and return on capital has declined every year for the past 5 years and competition both from big box and online has been tough. Recently inventory has increased which raises red flags, however this higher inventory level was anticipated and planned for due to the SAP transition. Extra inventory was purchased to avoid snags that can occur with such a significant switchover. The good news (as mentioned above) is the SAP implementation was successful and the company will now start reducing the inventory to more normal levels. There has also been insider selling of late through 10b-1 plans. Short interest is currently running about 14% of shares outstanding.
PLCE currently has a $100mm stock buyback in place. Due to the strong balance sheet, cashflow and valuation, this seems like a good use of excess capital.
PLCE is trading at about 4.5X 2015 EBITDA. As PLCE starts to execute on its growth and efficiency initiatives, PLCE could trade 7x EBITDA which represents a stock price of $70/share, 45% higher than the current stock price. This 7X multiple is still 25% lower than Carters multiple and with PLCE garnering more of its sales from the wholesale channel, PLCE may be compared more to Carters than in the past.
This is not a recommendation to buy or sell shares. The views expressed above are subject to change without notice and we may trade in any manner, whether consistent or inconsistent with this recommendation. The information above is from various public sources. The author has not independently verified this information and makes no representations as to the accuracy or correctness of any such information. Any forecasts made in this writeup are estimates and may not come to fruition. The author takes no obligation to update any opinions or information above which may change in any way at any time.