This Apparel Stock has Good Upside Potential

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Carter's (NYSE: CRI) is a leading manufacturer of baby clothes and sleepwear, and an emerging factor in playwear, which comprises two-thirds of the $23 billion industry. In July 2005, Carter's acquired OshKosh; combined, these two brands represented about 16% of the children's apparel market in 2011.

In my opinion, Carter’s is one of the best-run children’s apparel companies, with two of the strongest children’s apparel brands that offer the most value/quality in the industry. The stock has gained around 35% over the last year, and as a result investors may be cautious going forward. However, I believe the stock offers good value despite the recent run up, as the stock appreciation was a result of earnings upside rather than multiple expansion.

<img src="/media/images/user_13967/carter_large.PNG" />
Source: Ycharts

From the chart above we can see that the stock is still trading at the same multiple it was at a year ago. Moreover, the company looks attractively priced on a growth adjusted basis. Let’s compare the growth prospects and valuation metrics of Carter’s with its peers, including Gap (NYSE: GPS), Walt Disney (NYSE: DIS) and The Children's Place Retail Stores.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Gap</p> </td> <td> <p>Walt Disney</p> </td> <td> <p>The Children</p> </td> <td> <p>Carter’s</p> </td> </tr> <tr> <td> <p>Forward P/E</p> </td> <td> <p>13.40</p> </td> <td> <p>15.07</p> </td> <td> <p>14.69</p> </td> <td> <p>15.04</p> </td> </tr> <tr> <td> <p>Next Year Growth</p> </td> <td> <p>10.60%</p> </td> <td> <p>15.00%</p> </td> <td> <p>16.90%</p> </td> <td> <p>20.40%</p> </td> </tr> <tr> <td> <p>Past 5 Year Growth (per annum)</p> </td> <td> <p>11.01%</p> </td> <td> <p>6.06%</p> </td> <td> <p>18.18%</p> </td> <td> <p>14.76%</p> </td> </tr> <tr> <td> <p>Next 5 Year Growth (per annum)</p> </td> <td> <p>8.67%</p> </td> <td> <p>12.83%</p> </td> <td> <p>8.00%</p> </td> <td> <p>17.85%</p> </td> </tr> <tr> <td> <p>PEG Ratio</p> </td> <td> <p>1.71</p> </td> <td> <p>1.20</p> </td> <td> <p>2.17</p> </td> <td> <p>1.02</p> </td> </tr> </tbody> </table>

Source: Yahoo! Finance

From the table above we can see that The Children's Place looks highly overvalued, while Carter’s looks undervalued on a P/E basis. Carter’s and Walt Disney are the only ones expected to post better numbers over the next 5 years compared to the past 5 years. Moreover, Carter’s has the “best-in-class” expected growth next year. Going forward, there is significant opportunity for Carter’s to grow its businesses by expanding its retail sites (both the Carter’s branded stores and OshKosh branded stores are heavily under-penetrated vs. competitors, 800-1,000 stores).

Carter’s e-commerce business is growing in the high double digit range, which I expect to continue over the next couple years, and management is taking it in-house, which should expand the margins. I also see opportunity long-term for Carter’s to expand its international presence in select countries, and growing its current international licensees business by taking them in-house. Finally, the company is restructuring its supply chain to go 50% direct, which should take EBIT margins to the high teens.

Moreover, I don’t think the investors need to panic about the wholesale weakness as it does not point to a permanent slowdown. Carter’s wholesale declined 4.6% and, excluding off-price, was flat, which is slower than historical quarters with growth in mid-single digit to double-digit range. However, I don’t think this represents a permanent slowdown for Carter’s wholesale as the management indicated that there were timing issues with product that likely shifted sales to 4Q. The management, which is usually conservative, has also raised 2012 top line guidance (12% vs. 9%-11% previously), which shows confidence in top line. Moreover, spring orders for Carter’s wholesale have actually increased (orders now +6% vs. +5% previously).

To sum up, I think Carter’s offers a good investment opportunity despite the recent run up. The company looks attractively priced with respect to its peers on a PEG basis. The company has a good earnings momentum and I expect the trend to continue given international expansion and supply chain initiatives. Hence, I recommend buying this stock.

sandeep2gupta has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney. Motley Fool newsletter services recommend Walt Disney and Gap. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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