This is a summary of this week’s show. Listen in at Value Line Observer – Feb 5 2010
Val’s Three Best Ideas This Week
Carter’s Inc. (CRI)
Carter’s has brand in a retail niche in children’s clothes where it seems like it could matter. With a focus on quality and service, maybe you can build some loyalty with moms who like don’t mind if they can do all their baby shopping in one spot. Improving operating margins to the mid-teens, and a mid-teens return on capital suggest good management. The stock looks undervalued probably due to some accounting issues that may have put a cloud on the valuation multiple, combined with several top level management changes. The accounting issue ended up being a 1.5% of equity deal, or about 7% of last year’s earnings – certainly within most investors projection zone in any case. Still, the combination could keep some potential buyers out while they sort through it. I like the roughly 7x multiple of Enterprise Value to EBITDA, or a roughly 14% operating cash return on the invested enterprise value.
Family Dollar (FDO)
This company along with its long time competitor Dollar General, have been earning above average margins and returns on capital for decades. While one can argue that saturation will put a damper on future sales growth rates, that isn’t necessarily bad for returns when management not only pays a dividend, but consistently buys back stock. I’m not sure I thought of this during the show, but one of the company’s secrets to its consistently high return on invested capital is to use discipline in capital investment projects, while returning excess cash to shareholders. There would be more great companies if this simple principle were more widely followed. The stock has recovered off the lows, but the valuation remains below historical multiples and offers a private buyer a good return at a 7x Enterprise Value to EBITDA multiple, or, like Carter’s above, a roughly 14% cash return on investment.
Children’s Place (PLCE)
Similar to Carter’s, Children’s Place appears to have niche in children’s apparel that may be more grounded on quality and service as perceived by the mom, rather than any fashion element to the end customer. Results were historically more volatile at PLCE, which may suggest a bigger fashion element than at Carter’s or simply be a result of the weak performance of the Disney stores, which PLCE operated until 2008. Recent return on capital and operating margin have both moved to the 12% range since then. The company is recently showing better performance, yet trades at just a 4x Enterprise Value to EBITDA multiple, or a 25% cash on cash return. How can it be 12x earnings, just like Carter’s, yet 4x EBITDA? Not sure, but it very well may have something to do with the shutting down of Disney, and how assets may have been written down. There has also been a change in the CEO office, that could also keep pressure on the valuation. Whatever the case, PLCE is cheap.
Val Hughes
February 5, 2010
