It isn’t exactly the best time to be an apparel retailer and The Children’s Place, Inc. (NASDAQ:PLCE) isn’t an exception. The company is reporting declining revenues (Y/Y) and rising costs which have pushed it to an operating loss in Q2.
Investors and the market have a right to be cautious, but substantial declines from 52-week highs ($113) have de-risked a prospective investment in Children’s Place at today’s prices. In this article I will discuss some of the recent troubles, some reasons to be optimistic and why, on balance, I rate PLCE a hold.
Unsurprisingly feeling the heat
Children’s Place missed its own estimates by some margin in Q2, after feeling the pressure from the consumer spending slowdown. The company reported a GAAP loss of $1.01 on revenues of $380M (-8% Y/Y). In addition, they faced headwinds related to increased promotional activity from competitors and increased costs due to East Coast shipping bottlenecks. The majority of things outside of management’s control that could go wrong, did go wrong. It was therefore unsurprising that shares dropped off 8% following the announcement, especially after management’s internal forecasts were so far off.
PLCE had planned to offset increases in input costs (cost of sales jumped 8% compared to 2021 despite revenues declining), by increasing prices across the board. But the worsening consumer environment meant the company wasn’t able to budge up Average Unit Revenue (AUR). Higher Average Unit Cost (AUC) was also reflected in the 34% jump in inventory booked on the balance sheet. PLCE had previously benefited from booming consumer spending with strong pent-up demand and the positive impact of enhanced child tax credits. It’s clear now the notable COVID-related consumer tailwinds have reversed into headwinds as inflation has soared.
Many of these issues are expected to start to abate in Q3, though. Management guided for adjusted earnings per share of $3.95 for the coming three months. I would expect the shipping bottlenecks to start to ease over the coming quarter. Management touched a bit on this in the Conference Call:
I don’t know it might be too much information but 35 vessels that anchored at Savannah, which is a major improvement from where we’ve been. And then the Georgia Port Authority says that by the mid to the end of September, they should be back to “normal” and that we should not see that increase in Q4 again
Considering the inbound shipping delays led to a 150bp gross margin hit in Q2 due to rebalancing, a move in the right direction regarding shipping difficulties would be welcome news. The early signs so far in the quarter (Q3) are positive, but shareholders should still expect higher inventories and input costs through the quarter with a greater impact likely to be seen in Q4.
The positive – digital pivot accelerates
There are some reasons to be optimistic for PLCE shareholders, the declining physical retail sales have provided a platform for digital sales to continue to grab a bigger share of the revenue mix. In the last quarter, digital sales represented half of total sales. This was driven by a combination of both steep declines in physical retail sales and increases in digital sales Y/Y.
This is a big positive – the Ecommerce market still has a long secular growth runway, Statista estimates a 14.55% CAGR from 2022 – 2025.
There is arguably stronger competition in this market but that’s why it is beneficial that the company’s approach is multi-faceted. In fact, the retailers’ sales on Amazon (AMZN) (a very competitive marketplace) are growing a lot faster than expected.
On the whole, the business is expecting digital sales to increase to 60% of sales by the end of ’24.
The bottom line
Children’s Place now anticipates $1.725B in revenues for the full-year with adjusted earnings per share expected to be $7, nearly half of 2021 EPS. This means at current prices, PLCE is trading at ~7x EV/EBITDA. Cheap considering that half of the business is situated in a market with strong medium/long-term prospects, but these are only expected to replace lost retail sales – by ’24, analysts expect total sales to remain around $1.7B.
Therefore, investors must look to the margins and costs. Right now, the headwinds are harrowing, the business is getting squeezed from all directions with the Q2 miss providing a stark reminder of this. Following on from the Fed’s 75bp rate hike on Wednesday and subsequent aggressive future rate hike expectations, it looks likely investors will have to become accommodated to a higher interest rate environment for a while.
I believe it’s worth monitoring for the next quarter or two to see how the company now performs against internally renewed expectations and look for positive signs on both the input cost and demand side – even if that means paying a higher price. Hold.