The Children's Place (PLCE) shares offer a compelling opportunity to invest in a strong retailer at industry low valuations: 7.6x FCF (ex $5/sh of YE net cash on B.S.); 9.5x EPS (ex net cash); and 3.6x EV/EBITDA. PLCE is a specialty retailer of children's apparel, ages newborn to 14 years old. Since its focus is on value, PLCE has shown earnings resiliency during the recession, thanks to the trade-down effect and overall stability in the children's apparel space (necessity buying forces parents to shop for their children every season). In fact, EPS is projected to grow to ~$2.40 in 2009 from $2.24 in 2008.
WHY THE VALUATION DISCOUNT?
a) Lack of a permanent CEO. For all of 2009, PLCE did not operate with a permanent CEO. On December 11, 2009, PLCE announced the appointment of Jane Elfers as its new President/CEO effective Jan 4, 2010. She has a strong merchandising background and is credited with turning around Lord & Taylor. Having a permanent leader with a proven track record should lift the valuation discount in 2010 as her strategies to improve performance become known.
b) Ezra Dabah overhang. Earlier this year, the former CEO/Chairman launched and lost a proxy battle to replace 3 board members. His 5mm share (18% ownership) position became a major overhang. However, in August, an agreement was reached for the Company to repurchase 50% of his position. The other 50% was to be sold in the open market. As of his last 13-D filing on 10/14/09, Ezra had 1mm shares remaining. At this point in time, it may be possible that he has completely sold his position, thus eliminating the overhang.
c) Erratic monthly SSS and earnings results. A review of PLCE's recent SSS results and change in 2009 EPS expectations would suggest performance akin to a rollercoaster ride. The stock's most recent big drop can be attributed to missed November SSS expectations, which came in at a staggering -13% vs. consensus at +2%. Children's apparel, for better or worse, is highly dependent on weather. Unfortunately for business, November was unseasonally warm and resulted in parents lacking the need to purchase sweaters and jackets for their children. Thankfully, December weather has been favorable and the most recent consensus estimates for December SSS of -5.6% represents a low bar to cross. The fact that PLCE pushed back their storewide clearance event until after Christmas instead of before (where it has been in years past) suggests to me that December traffic and promotions had been tracking well (if not ahead of expectations) leading up to the holiday.
WHERE ARE THE OPPORTUNITIES HEADING INTO 2010?
a) Margin Improvement Opportunities. PLCE management has a target of achieving low double digit margins. This is no pipe dream. Their closest peer, Gymboree (GYMB) commands operating margins ~800bp higher; of course, some of this gap is structural given that GYMB has a higher average unit retail (AUR). Nevertheless, closing the gap by a few hundred basis points is certainly possible, as evidenced by PLCE's Q3'09 results where operating margins came in at an impressive 14%.
PLCE will experience gross margin tailwinds into the 1H of 2010, as they will realize higher initial markups (IMU) and currency tailwinds (13% of sales are from Canada). As most of the major cost-cutting initiatives have already been implemented and realized, I do not expect more to come out of SG&A in 2010. For 2010, I am modeling 80bp of GM improvement (+120bp in 1H'10 and -40bp in 2H'10) and SG&A growth in line with square footage growth.
b) Easy SSS comparisons in 2010. SSS comparisons are not too heroic in Q1'10 at +1%;however, they get extremely easy beginning in Q2 at -9% and Q3 at -2%. Due to the inherent volatile nature of SSS in the children's apparel space, I believe management may stop reporting monthly comps. This should help reduce volatility in the shares.
c) Possible Takeout Candidate. Along with its ridiculously low valuation, PLCE's FCF characteristics make it an attractive LBO candidate. Running PLCE through an LBO model with conservative assumptions spits out a mid 20% IRR at a $45 takeout price (I am assuming 60% equity contribution, 10% interest rate on debt, and 6x exit multiple). A recent note by Citi (12/15/09) cites average retail M&A transactions at 8.8x EV/EBITDA. While an 8.8x EV/EBITDA valuation seems aggressive given today's environment, Advent's recent purchase of Charlotte Russe (closed 10/14/09) for 7.7x suggests that deals are starting to get done and at valuations materially above PLCE's current valuation. At 7.7x, PLCE's implied stock price would be $58.
While I certainly acknowledge that results could be choppy in the future, low expectations, a steep valuation discount, good margin opportunities, the possibility of a takeout, and easy comps heading into 2010 provide compelling reasons to own PLCE now.
a) SSS and EPS misses
b) Worsening of economic & retail sales data
c) Strengthening of USD vs. CAD
*+2% Comps/+3% sq footage growth
*80bp of YoY GM improvement/SG&A growth in line with sq footage growth
*41% Tax rate
Target Price Calculation
+ '10 YE Net Cash
Jan 7th - December SSS results are reported. I believe current expectations of -5.6% are beatable given the favorable weather.
Q4'09 results - Although I believe current consensus EPS of $.73 may still be too high as some analysts have not adjusted their Q4 numbers (I am at $.69), I think some recent notes have lowered the real expectations to the ~$.60 range.
PLCE Analyst Day (TBD) - I expect PLCE to host an analyst day in the 1H of 2010; this will be the forum where new CEO Jane Elfers will layout her strategy for PLCE.