by Lawrence Meyers | May 24, 2012 7:00 am
You must be careful with clothes. Trends are temporary. Taste is fickle. Not only do you not want to end up at a glitterati party in Abercrombie & Fitch (NYSE:ANF) when American Eagle Outfitters (NYSE:AEO) is all the rage, but you also don’t want to get caught holding a clothing-retailer stock when its time in the sun has past. The market is littered with clothing stocks that skyrocketed and then crashed.
The one exception to this warning is children’s clothing. Two companies in kids’ wear have experienced stock volatility, yet over the long run have managed to recover anytime their stocks get overpriced and then fall: The Children (NASDAQ:PLCE), better known as The Children’s Place, and Carter’s (NYSE:CRI).
I suspect the reason why these stocks don’t have the same stock patterns as their adult equivalents is that children’s clothing, particularly for toddlers and babies, is not dependent on fashion trends. Simply put, kiddie clothes simply need to be “cute,” and “cute,” in this world, has a very broad definition. As long as it’s not a burlap sack, you can get away with just about anything.
And that’s what these two companies do: sell cute clothes. They also sell them at attractive price points so that as the child grows, it’s not terribly expensive to buy the next size up. And since there’s an endless supply of new children coming into the market, these companies have plenty of business.
So is one a better buy than the other?
The Children, whose storefronts say The Children’s Place (why not call the company that?), operates 1,049 stores and has an outstanding balance sheet. It has $204 million in cash (almost $9 a share) and no debt. It consistently generates $80 million to $90 million of free cash flow annually.
But growth has been stagnant for years. Net income has just flopped around the $80 million mark since 2009, and that won’t change much this year. Revenues have also maintained similar levels, just inching up a tiny bit year to year. Cost-cutting seems to be driving the 10% earnings growth this year, and analysts see 8% annualized going forward.
So you’re paying 11x earnings (including cash) for a no-growth company that generates $3 per share in free cash annually, with no dividend. This feels like a trading stock to me, and its chart is volatile enough that you can do that successfully. Either wait for the stock to visit $20 again, or take advantage of its volatility by selling covered calls or naked puts. It’s the kind of company that won’t go bankrupt and is on solid footing, so you can play those games.
Carter’s has $300 million in cash and $236 million in debt, or about $2.50 per share in cash. It also routinely generates $45 million or so in free cash flow. Carter’s had been growing earnings at a solid clip, but then it got hammered in 2011 on skyrocketing costs. However, it looks to be back on track with 19% annualized growth going forward. It would be a lot better to buy this stock outright since it trades at 19x this year’s estimates — right on target with its growth rate.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at SeekingAlpha.com. He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.
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