Here's Why Carter's (CRI) Offers A Balanced Risk-Reward Now

Carter’s Inc. (NYSE:CRI) has been on the growth trajectory lately backed by its efforts to enhance omni-channel and e-commerce capabilities. Further, its co-branded stores are likely to aid sales. Additionally, the company’s Retail strategy, which is focused on improving store productivity, strengthening e-commerce business and enhancing product offerings, has kept the stock in investors’ good books.

These factors have collectively contributed to solid share price trend in the past three months. The stock has gained 16.4% in the past three months, outperforming the industry’s growth of 10.6%.

However, the company is exposed to tariff threats due to the introduction of tariffs on List 4 goods. Also, adverse currency rates are hurting the company’s performance. Moreover, it expects high inventory levels to persist in the quarters ahead.

Amid these lingering headwinds, let’s see how this Atlanta, GA-based apparel company can retain its momentum.

Factors Favoring the Stock

Carter’s is seeking opportunities to strengthen e-commerce capabilities through investments to speed up deliveries. Notably, the company registered double-digit growth in e-commerce sales in the third quarter of 2019, with e-commerce penetration improving to 30% of sales. E-commerce investments in the past year included re-launch of its website in summer, better engagement for online customers and higher conversion rates.

Additionally, Carter’s is making investments to strengthen its mobile app, which is likely to be re-launched in 2020. Further, its brands are sold online at sites of its wholesale customers. On a combined basis (including sales at its website and through wholesale customers), the company expects total online sales to exceed $1 billion in 2020.

Moreover, Carter’s has been making efforts to enhance omni-channel capabilities. In this regard, the company is benefiting from the same-day pickup service for online orders, easy access to a broad array of online products when shopping in stores and easy access to its new credit card program. This has led to an increase of 13% in multi-channel customers driven by improved experiences.

Also, Carter’s Retail strategy remains impressive. The company is enhancing product offerings by introducing extended sizes for the Carter’s brand and expanding Skip Hop brand offerings. Additionally, it is witnessing a positive response for its co-branded stores, which is a one-stop shop for families with young children. These stores have been the most productive lately, receiving the maximum return on investment. In the third quarter, co-branded stores were one of the best performing store types.

Backed by the success of these stores, management plans to open more than 100 co-branded stores in the next five years. Additionally, it envisions more than 80% of its stores to be co-branded by 2021.

Driven by these endeavors, Carter’s is witnessing robust earnings surprise trend. Notably, the company reported the fourth straight quarter of positive earnings surprise in third-quarter 2019. Earnings gained from solid growth in the U.S. Retail and Wholesale businesses along with robust demand for its merchandise. Further, the company discontinued with its soft margin trends in the third quarter.

Factors Hindering Growth

Though the aforementioned factors make us optimistic about the stock’s potential, there are some hurdles in its path. The most prominent concern is the impact of tariffs and adverse currency. Moreover, high inventory levels pose a threat.

After negotiations with suppliers and significant pricing actions, Carter’s has reduced exposure to unmitigated tariff threats to $30 million annually from $100 million impact expected earlier. To battle the cost increase, the company has significantly lowered exposure to goods sourced from China, reducing it to 15% heading into 2020 compared with 26% at the beginning of 2019. Although supply-chain initiatives and other efforts in this direction have helped mitigate this hurdle to some extent, the company still remains exposed to additional tariffs.

Also, the company continues to be affected by negative movements in foreign currency. The most impacts of adverse currency are felt on the overall top line and sales of the international segment. Moreover, Carter’s is struggling with higher inventory levels due to rise in wholesale demand and new retail stores, lower provisions for inventory, and product cost increase. This might continue to mar results in the quarters ahead.

Wrapping Up

The above discussion suggests that Carter’s has balanced risk-reward. Its efforts position it for long-term growth while headwinds may weigh on the near term results. Further, the Zacks Rank #3 (Hold) company’s expected long-term earnings growth rate of 7.7% speaks well of its growth potential.

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