Description

Company Overview

Carter’s Inc. is the largest designer and brand marketer of babies and kids’ apparel in North America.  Selling its products under the well-known global brands of Carter’s and OshKosh B’gosh (OshKosh), along with lifestyle brands Skip Hop and Little Planet, Carter’s provides high-quality apparel and accessories for newborns through pre-teens.  Operating for nearly 160 years as a stand-alone company, Carter’s acquired OshKosh (2005), Skip Hop (2017), and launched Little Planet (2021), consolidating its leadership in the children’s apparel market.

Carter’s is an essential core product for growing families with its wide array of apparel from onesies, blankets, and towels to its pajamas, t-shirts, and activewear.  The company holds a #1 market share position in the US, Canada, and Mexico in children’s clothing.  Carter’s sales represent over 10% of the US children’s apparel market (newborn to 10 years).  In the toddler market (ages three to four), their market share improves to 12%, and in the baby apparel market (newborn to two years) Carter’s market share is greater than 20%.  Eighty percent of Carter’s sales stem from its baby and toddler segments.

The company’s revenues are generated from three main segments:  US Retail, US Wholesale, and International.  At 51% of revenues, US Retail is the largest segment and consists of sales from company-owned retail stores (802 locations) and its ecommerce websites.  The US Wholesale segment generates 34% of Carter’s revenues from sales to US wholesale partners at 19,350 locations which include exclusive brands designed specifically for Walmart (Carter’s Child of Mine), Target (Carter’s Just One You), and Amazon (Simple Joys by Carter’s).  Finally, the International segment makes up 15% of revenues from sales of Carter’s products outside the US mostly through company-owned retail stores in Canada (188 stores) and Mexico (59 stores) and ecommerce sites.  International also includes wholesale relationships and licensees outside the US.

Industry Overview

The children’s apparel industry is highly fragmented with a mix of established brands and a revolving door of new entrants.  These brands focus primarily on particular segments within children’s apparel: luxury, premium, mid-range, and budget-friendly, and are divided even further by the ages they design for (newborn, toddler, kids, and tween).  Quality of product, material, durability, and price are the key factors each consumer considers when making a purchase.  Identifying which apparel segment, price, and age group a company markets to is paramount when targeting the right demographic, locations, and distribution channels needed to reach the apparel company’s key consumers. 

In the children’s apparel market, women aged 25-40 from diverse ethnic backgrounds and income levels are the key consumer demographic.  This group of women is not the biggest spender per visit but shops more frequently than any other age group.  Department stores, discount retailers, and specialty apparel retailers actively stock children’s apparel to attract mothers and drive traffic to their stores.  Unlike previous generations, women shoppers are more tech-savvy using both ecommerce sites and mobile devices to complete their transactions.  They also want the flexibility to be able to receive their purchase at the store, curbside, or through delivery. 

Children make up roughly 25% of the worldwide population but this number is heavily skewed to developing countries where the fertility rate remains well above 2+ children born per mother.  Growth in the children’s apparel market in these countries remains strong but is primarily focused on budget-friendly and surplus/clearance inventory.  In countries where the fertility rate is at or just above 2 births per mother, the growth of the children’s apparel market has been commensurate with growth in income, home ownership, and urbanization.  In developed countries like the US, Canada, and Europe, fertility rates have fallen from 2.3 births per mother in the 1970s to roughly 1.7, 1.5, and 1.6 births respectively.  Children’s apparel unit growth has remained steady in developed countries as the average selling price per unit has increased.

Investment Thesis

Children’s apparel, especially in developed countries, is not a growth industry but that does not mean that shares of Carter’s cannot have meaningful appreciation from their current share price.  Given its past investments and expansion in both its ecommerce and omni-channel platforms, along with strategies to offset the impact of higher material, production, and shipping costs, Carter’s operating margins, cash flows, and profits are expected to continue to improve in the future.  Given management’s willingness to return a large portion of its free cash flows to shareholders in the form of dividends and share repurchases, an investor does not need a huge tailwind to get a nice return on their investment.

Carter’s Competitive Advantages

For nearly 160 years, Carter’s Inc has been a lead designer and brand marketer of babies and kids’ apparel.  Over that period of time, they have distinguished themselves as outstanding operators.  In their retail and international operations, they have consistently produced mid-teen operating margins, with wholesale achieving the upper teens.  What separates Carter’s from other children apparel marketers/retailers is not only the size, scale, and scope of their operation but their ability to quickly pivot to a changing consumer environment. 

Retail

In the years after acquiring Osh Kosh, Carter’s attention was focused on integrating and expanding the newly acquired brand with its wholesale partners and into its own retail store locations.  Because of the distraction, Carter’s was admittedly late to embrace online retail and was missing out on the growing direct-to-consumer (DTC) opportunity from young mothers migrating to shopping online.  By 2010, the company launched its ecommerce platform and has worked to continuously improve the platform and reduce costs.  Unlike other apparel retailers, Carter’s continued to expand its store locations even as online sales were improving.  The company discovered that ecommerce sales are most robust in areas that have a Carter’s store location.  This prompted the company to invest in building out its omnichannel platform to be able to use its local stores’ inventory to fulfill customer orders.  Omni-channel fulfillment played a key role during Covid and has helped Carter’s strengthen its efficiency and customer experience.  Over the past few years, the company has continued to focus its attention and investments on building out a robust ecommerce/omnichannel sales platform that is roughly 39% of its retail sales.

Wholesale

As slow as Carter’s was to embrace ecommerce, they were quick to shift from being a traditional wholesaler to partnering with many of the largest national retailers.  These partnerships range from seasonal planning, retail-specific promotions and marketing, setting up a Carter’s “store” within the retailer’s store, and proactively managing the retailer’s inventory.  Where Carter’s made a major pivot, and remains ahead of its competition, was when they created exclusive brands for Walmart, Target, and Amazon.  Each exclusive clothing line is unique and represents the colors, patterns, and apparel items selected by each retailer. 

In essence, Carter’s became the private label manufacturer for the largest retailers in the US.  Unlike other private label deals, Carter’s brand/name remains part of the clothing line (Carter’s Just for You, Carter’s Child of Mine, and Simple Joys by Carter’s).  The partnerships also allowed Carter’s to leverage its design, marketing, and logistics expertise while receiving special accommodations for its products.  One of the major reasons why Carter’s was able to create and expand the partnerships is that they are one of the few companies with both the size and scale to design, manufacture, and deliver clothing that is not only unique to each retailer but also deliver a different variation of the clothing lines to the retailer’s stores based on their geographic location.

Inventory, Logistics and Supply Chain Management

Carter’s inventory & supply chain management is the key to the company’s success.  In any given year, the company will add upwards of 24,000 new product styles, manage over 400,000 SKUs, and ship over 700 million units.  To achieve scale and reduce costs in retail, especially apparel, companies’ supply chains need to source globally, execute locally, while efficiently managing complexity across its operations.  Over the years, Carter’s has refocused its supply chain and logistics to streamline production, manage both store and distribution center inventories, speed up deliveries, and reduce costs.

Carter’s ERP system has been refined to allow for mass customization and late-stage adjustments while producing dozens of versions of each style to meet the particular needs of their end customers.  Once manufactured, these units are then assembled, tagged with retailer-specific price tags, and packaged (majority with hangers) based on retailer’s requirements.  By working closely with its manufacturers, Carter’s is able to offer this level of customization and flexibility to its wholesale customers, a level of complexity that many of its competitors cannot or will not offer.  Over time, Carter’s has been able to reduce the number of its manufacturers, increase its unit volume, improve the efficiency of its distribution centers, trim its delivery days, all while saving money and improving working capital.

Carter’s operations are not immune to the impact of inflation but its flexible supply chain allows it to react more quickly and recover faster.  Over the past four years, Carter’s has had to navigate an incredibly challenging supply chain, logistics, and economic environment.  Starting in 2020, the company’s materials, production levels, and inventories were all meaningfully reduced because of the outbreak of Covid.  By 2021, production levels were improving but inventories remained low because of the pent-up demand from the previous year.  Just as Carter’s product supply and demand were coming into balance, inflation began impacting the cost of its raw materials, shipping, & transportation costs.  By late 2022/early 2023, inflation was impacting the price of all goods and services as Carter’s customers were reducing their average spending and frequency of shopping trips.  To clear inventory, Carter’s wholesale partners and retail stores began cutting prices and marking down items which negatively impacted margins and profits.  With Carter’s flexible supply chain, the company was able to reduce its unit production but since its supply chain is designed for high volume, the cost savings were limited.  Since many of the company’s basic items are not seasonal, Carter’s reverted to “pack and hold” inventory to distribute at a later date.  Eventually, the company was forced to raise prices, recognizing that it was not going to cover its inflated costs.  It took about 4 seasons (12 months) for Wholesale inventories to be worked down.  Recently, Carter’s has seen improved reorder rates and volumes increase.  In a recent earnings call, the company’s management guided for revenue & unit growth building in the second half of 2024 and into calendar 2025.  Carter’s actions to reduce costs during the spike in inflation will start to have a positive impact as the company rebuilds its production levels.

Competition

Competition among child apparel companies remains extremely cutthroat.  Starting in 2018 and extending through 2020, over 1700 children’s apparel stores closed as companies like Babies R US, Bon Ton, and Gymboree/Crazy 8 went into bankruptcy.  Bon-Ton re-emerged as an ecommerce website under brandx.com and Gymboree/Crazy 8 brands became part of The Children’s Place.  Babies R Us and Bon-Ton’s bankruptcies closed over 1100 stores and eliminated $200mn of Carter’s sales.  At the same time, the closures helped drive traffic to Carter’s existing stores and ecommerce platforms.  Carter’s remains committed to retail stores as its data shows that new and existing stores help drive its ecommerce sales.

The Children’s Place, which competes directly with Carter’s for the exact same consumer demographic, is the second largest US children’s apparel marketer and is facing the same challenging economic environment.  With ~$13 million in cash (~45mn with credit facility) and roughly $390 million in debt, The Children’s Place has been closing down store locations in order to reduce expenses and conserve cash.  The concern is that The Children's Place will have a liquidity issue forcing them into bankruptcy and restructuring. 

Valuation

With $150 million of net debt ($350 million in cash & $500 million in debt) and free cash flows that average $285 million for the past 10 years, Carter’s Inc. is in good financial health.  Over the past 10 years, the company has generated $2.8 billion in free cash flows, and during that same period, returned $2.6 billion back to shareholders in the form of dividends ($700 million) and share repurchases (1.9 billion). 

The company has guided for a stronger 2^nd half of 2024 with yearly revenues improving to $2.975 billion, slightly better than 2023.  If revenues were to grow modestly at 2.5% over the next three years, total revenues would improve to around $3.2 billion.  With its historic net profit margin of 7.9%, Carter’s would generate $253 million in net income.  Over the past 10 years, the company has spent on average $180 million per year repurchasing its shares.  Assuming the company continues to repurchase its shares but at half its average, Carter’s share count would go from 36.6 million shares to less than 33 million and its EPS would be around $7.65.  Applying a 15 multiple would generate a share price of roughly $115 or an 85% increase from today’s share price and a 100% return assuming Carter’s maintains its 5%+ dividend.

Risks

Economic uncertainty is the biggest risk facing Carter’s Inc.  The company’s sales reflect the spending habits of growing families and both deflation and inflation will impact the amount of money a household has to spend.  There is a risk of cheaper children’s apparel flooding the market but given that Carter’s is a trusted brand among young families and many of its items are less than $10, that risk appears limited.  A longer-term risk facing Carter’s is that new families grow accustomed to spending less on children’s clothing and that trend continues beyond the economic challenges.

Conclusion

The past four years have been a very difficult environment for Carter’s Inc. and its current share price reflects those headwinds.  Having navigated the supply chain and logistic challenges during Covid, the company was immediately hit with higher input costs, increased shipping costs, and declining consumption.  This led to high inventory levels that needed to be worked down while managing its future production levels. 

Carter’s implemented a number of strategies to reduce production and inventory levels that have been overshadowed by lower consumer demand.  After keeping their inventories lean for the past year and a half, it appears that retailers are finally beginning to rebuild for the second half of 2024.  Recovery will take time, but growth is expected heading into calendar 2025.

Given its strong financial health, it will not take a lot of growth for Carter’s margins and profits to recover.  Even during the recent economic headwinds, Carter’s continued to return money to its shareholders through dividends and share repurchases.  Many of the improvements Carter’s made over the past four years have yet to be reflected in its margins.

Catalyst

• Economic improvement/slowdown in inflation.
• Improving revenue and margins.
• Management's willingness to return capital to shareholders through dividends & share repurchases.