Kids’ apparel and accessories retailer Children’s Place Inc. (PLCE, Financial) delivered a weak quarterly result this week, which caused its stock price to plummet by nearly $10 in one trading session. While there has been a mild resurgence, the stock has already lost more than a third of its value in the past 12 months. Investors continue to raise a number of questions regarding the rationale for its recent Gymboree acquisition and the outlook of the business.
The Gymboree acquisition impact on the recent results
Children’s Place had a dramatic fourth quarter: It missed both revenue and earnings estimates. The company’s revenue for the quarter was $530.56 million, a decline of 6.9% from the corresponding quarter last year. It missed analyst estimates by $22.5 million. There was also a slight decline in same-store sales of 0.6%.
But the highlight of the quarter was the acquisition of the popular children’s clothing brands Gymboree and Crazy 8. The company managed to acquire Gymboree assets for a seemingly distressed valuation of $76 million as the Gymboree Group had filed for bankruptcy in January 2019. However, the problem with getting the assets cheaply was the potential cannibalization as there is a 70% overlap in the locations of Children’s Place and Gymboree. The proximity of Gymboree stores to those of Children’s Place, and its accelerated inventory liquidation, negatively impacted the company’s fourth quarter and is expected to affect the first quarter of 2019. However, the management believes that the cannibalization will be minimized and the synergies with respect to the new stores will kick in after the second quarter of 2019.
A Short Term Impact On Margins
The company witnessed a near-term decline in margins as a result of the management’s decision to accelerate the liquidation of seasonal carryover inventory. There was also the fact that the company had a weaker than expected Christmas season. Store traffic declines and lower conversion rates in the weeks leading into Christmas resulted in an adverse impact on the earnings. Also, the company had to incur higher fulfillment costs as a result of higher freight expense associated with an unplanned ship from store activity. All these factors were responsible for the lower-than-expected margins and it is highly likely that they will not persist for the coming quarter.
The Store Fleet Optimization Initiative
The purchase of Gymboree brands also ties into Children’s Place's store fleet optimization initiative, which aims to close at least 300 stores by 2020. Under the initiative which began in 2013, 211 stores have been closed so far and the company managed an increase in its overall operating margin by a reasonable amount. The management expects that insight into Gymboree's portfolio provides them the opportunity for better profitability and productivity besides an increase in market share. In fact, they have already clarified that they would not add net square footage while taking advantage of Gymboree's own store exits. This focus on productivity is a big green flag in favor of the company.
E-Commerce: If You Can’t Beat Them, Join Them
In order to take on the challenge of the shifting mall and store purchases to online purchases which are led by Amazon (NASDAQ:AMZN), Children’s Place is using a multi-pronged strategy. The company is working towards building its own e-commerce footprint via its www.childrensplace.com platform and introduced the Buy-Online-Pickup-in-Store (BOPIS) in 2017. The management is working on further streamlining this service while the contribution of e-commerce revenues has increased to as much as 28% of the top-line.
Another strategic move by the team was to partner with Amazon as a wholesaler under ‘Amazon Basics Replenishment’ in 2016, and in 2018, launched ‘Amazon Fashion Replenishment’. It also opened the Children’s Place brand store on Amazon and has taken part in Amazon Prime Wardrobe launch.
International Expansion To China And Beyond
Children’s Place caters to North American markets of the United States, Canada, and Puerto Rico via 972 stores. Internationally, the company is operating in 20 countries through 8 franchise partners. With its stores, shop-in-shops, and e-commerce, Children’s Place added 27 new points on distribution in 2018 and is expected to add another 40 points in 2019. In China, it partnered with Semir, which runs China’s top children’s retail chain ‘Balabala’. Under this partnership, Semir will open over 300 locations for Children’s Place in Greater China as well as manage its e-commerce business in China.
Is Children’s Place Undervalued?
As mentioned earlier, the company’s stock has gone through a fair bit of highs and lows in the past few months. Children’s Place is currently trading at an EV-Ebitda multiple of 7.95 and an EV-Revenue multiple of below 1. The resultant Price to Earnings is hardly 15 which is on the lower side for a company with a 3-year revenue growth rate of 11.40% and a 3-year EPS growth rate as high as 29%. The amount of debt on the Balance Sheet is also nominal given the Debt-Equity ratio of 0.16. This implies that the fundamentals of the stock are strong but the valuation is not high.
Conclusion
In the words of the company’s President and CEO Jane Elfer, opportunities such as the one from Gymboree will continue to appear in the specialty children's apparel market that will help the company grab a larger piece of the pie. Although the stock price may have taken a beating, the management believes that Children’s Place is in a better position to take strategic advantage of this consolidation with a strong balance sheet and cash flow position. The valuation is also reasonable and gurus such as Joel Greenblatt (Trades, Portfolio) have re-entered the stock recently. Given all these facts, Children’s Place certainly deserves to stay on the portfolio of growth investors.
