Children’s Place: Impressive Q2, And The Stock Is A Buy Under New Management (NASDAQ:PLCE)

The Children’s Place, Inc.’s (NASDAQ:PLCE) Q2 2024 was impressive, with the company returning to adjusted profitability in a slow quarter after only one quarter of the new controlling shareholder. The company did so while losing sales, by shedding the most unprofitable ones (free shipping and super discounted) as was commented since my first article on the company. The stock reacted aggressively post earnings, climbing 85%.

Although management’s comments have been scant, I believe their current strategy is correct: avoid unprofitable sales, stop discounting and offer free shipping. Of course, that can only help the company stop bleeding, but growing is a different issue altogether.

After the rally, PLCE trades at a market cap of $115 million, which is very low compared to the real potential of generating more than $50 million in net income in the next twelve months if the management continues recapturing margins. Although the company still has cyclical and financial risk, I believe its yields are very opportunistic, and now consider the stock a speculative Buy.

2Q24 results

Make money by selling less: PLCE revenues fell close to 8%, and I have reason to think their volumes fell even more, but the company’s gross profits grew 27%. That type of result can only happen in previously very mismanaged companies.

The promotional void: As commented since my first article on PLCE (before the managerial and control change), the company suffered from an excess of proportionality, as seen in steep discounts on its webpage, coupled with free shipping on any order. With AUR that are well below $10, a lot of PLCE’s online sales were probably loss making.

The new management decided to stop free shipping for such small orders. Today, visitors to PLCE’s website cannot find references to free shipping or even discounted shipping, and the discounts offered are much smaller and for clearance products mostly.

Second-order benefits, positive store comps: The limitation to website proportionality carried other benefits. The company saved money on advertising and shipping (allowing it with other cuts to post lower SG&A YoY), and traffic to its stores improved, with retail posting its first quarter of positive comparables since 2021.

Cleaning the fat: PLCE also cut on the store payroll, and what it calls the “home office payroll.” The company probably had plenty of employees from the high business COVID-19 era that remained in adjacent functions with low productivity. This helps reduce the company’s burn and makes it more lean for a potential rebound in sales.

First quarter of operating profitability: PLCE posted adjusted operating profits for the first time since 2021. The company recorded operating losses of $22 million, but this includes $28 million in impairment of the Gymboree brand (non-cash), meaning that actual operational profits were closer to $6/7 million. The company also adds back $7 million in restructuring costs (like stock compensation to the new managers and severance to employees), but I prefer not to add back these costs as the company continues its restructuring.

Lower liquidity risk: Thanks to the long-term loans provided by the controlling shareholder (as discussed in my latest article on the company), the company has liquidity to go a few extra seasons. Today, PLCE owes $170 million to its controlling shareholder ($80 million of which is interest free, and $90 million of which pay SOFR + 4% deferred for one year). In addition, it has an open balance of $320 million in a credit facility (paying SOFR + 3%). The facility is currently drawn heavily because the company is expecting to enter the busy season in the second half.

Valuation

Busy season ahead: The company posting operating profits in 2Q24 is a good sign because 2Q24 is the slowest moving quarter for PLCE. The company usually makes more than 2/3 of its sales in the second half of the year. For any retailer, sales volume is critical for operating leverage, so we could potentially see a continued improvement in PLCE’s margins in the future.

Earnings potential at new margins: Since the beginning, my thesis on PLCE was that the company could make more profits by selling less if those sales came at higher margins. The company pulled it off in 2Q24, with gross margins improving by almost ten percentage points to 35%. This is still below the historical average of 37%.

Let’s suppose that PLCE continues to shed sales at the current rhythm of 8%. However, those new sales are made at a better gross margin of 35%. In that case, the company would post gross profits of about $515 million for the year, compared to $445 million in FY23.

From that, we can remove TTM SG&A of $410 million (we are not adding back the $28 million in Gymboree impairments nor considering further cuts in SG&A, which are likely). This would lead to an operating income of $105 million.

In addition, we have to consider debt payments of $8 million per year to the Mithaq loan and about $25 million to the credit facility. That would remove $33 million in interest, leading to pre-tax income of $72 million, or net income of $55 million (considering no allowances from NOLs, which are probably plentiful). This is well below what the company generated in net income before the pandemic.

Risks

Low-hanging fruit mostly taken: PLCE has already applied the most important measures to recover profitability by slashing unprofitable sales. It made no sense to make this sale in the first place unless to maintain growth for growth’s sake. If the company maintains this philosophy in the second half, it will reap significant rewards even with lower sales and lower traffic.

But to continue making the profitable sales, the company has to pull off good products at an attractive quality/price ratio. If the company fires too many people in the critical departments of merchandising, design, marketing, it may hurt its normal sales too.

Leveraged into a recession: The company still owes a significant amount to its controlling shareholders and its banks. This leaves the company heavily exposed to a challenging season in which it cannot fully recover cash from its inventories, leading to even more debt. This type of risk also includes an economic slump in which consumers cut back on apparel spending.

Conclusion

PLCE’s management is doing what is needed to return the company to profitability. Based on my forecasts, the company could be on a route to generating $50 million plus in net income in the next twelve months. This is well below its historical profitability.

Compared to this, the company trades at a market cap of $115 million. Despite the risks related to the restructuring and the leverage of the company, the prospective yield offered in high.

For that reason, I consider PLCE a speculative Buy.