It’s been a little over a month since Children’s Place (PLCE) announced on Feb. 16 that it obtained $130 million in much-needed debt financing. A week earlier, it reported preliminary unaudited results for Q4 2023. They were not impressive. Its shares fell by 52% in a single day.
Due to the massive correction in its share price, Children’s Place was on Barchart.com’s Bottom 100 Stocks to Buy list on Tuesday with a weighted alpha of -74.40, putting it in the 89th spot. This is not a list you want to make.
The children’s specialty retailer’s stock is down 65% over the past year and 85% over the past five years. Yet in November 2018, its shares traded near $160.
Ever since the collapse of the Rana Plaza factory in Bangladesh in 2013, when more than 1,000 garment workers lost their lives, I’ve been suspicious of apparel companies and their manufacturing processes.
While I’m not suggesting Children’s Place has anything to hide on this front, it seems poetic justice that its share price has lost most of its value since 2018. But I digress.
For investors, the issue is whether the latest news represents a buying opportunity or a sign of steering clear.
Is Children’s Place a value play or a value trap? I’ll consider both sides of the argument.
PLCE Is a Value Play - Part 1
Before getting into valuation, let’s consider the retailer’s current circumstances.
As I mentioned earlier, the company announced preliminary Q42023 earnings on February 9. On the top line, the company said its revenue would be as low as $454 million, flat to Q4 2022. On the bottom line, it now expects to lose at least $2.90 a share in the quarter, probably more. This is down from a year ago when its adjusted loss per share was $3.87.
Based on these numbers, Children’s Place should generate 2023 revenue of $1.60 billion and an adjusted net loss of at least $47 million, or $3.76 a share. That compares to revenue of $1.71 billion in 2022 and an adjusted net loss of $1.1 million, or $0.08 a share.
In March 2023, despite calling for a Q1 2023 adjusted loss per share of at least $1.60, it said it would earn at least $2.50 for the entire year. That’s a far cry from an expected $3.76 a share loss.
Because the reality is so much different than its guidance, class action lawsuits have come out of the woodwork.
Rosen Law Firm, which specializes in investor rights and is gathering plaintiffs, said this about the situation in a March 15 press release:
“According to the lawsuit, defendants made false and/or misleading statements and/or failed to disclose that: (1) The Children's Place was engaged in aggressive promotions; (2) as a result, The Children's Place's inventory values were overstated; (3) the foregoing was reasonably likely to have an adverse impact on fiscal 2023 financial results; and (4) as a result of the foregoing, defendants' positive statements about The Children's Place's business, operations, and prospects were materially misleading and/or lacked a reasonable basis.”
Lawsuits aside, let’s consider its valuation.
PLCE Is a Value Play - Part 2
Children’s Place’s enterprise value is currently $703.3 million, according to S&P Global Market Intelligence. Based on 2023 revenue of $1.60 billion, its EV/Revenue multiple is 0.44x. In 2018, when it hit $160, its EV/Revenue multiple was as high as 1.32x but averaged 0.72x, 64% higher than today.
Without considering profitability and based solely on sales, it’s undervalued relative to its historical valuation.
As for operating profits, the retailer’s highest amount generated was in 2017, at $166.7 million on $1.87 billion in revenue and an operating margin of 8.9%. The following year, when its share price went to $160, its operating margin had fallen 280 basis points to 6.1% on $1.95 billion in revenue.
However, over the past decade, it’s only lost money twice on an operating basis, in 2020 and 2023.
The big problem for Children’s Place is that it’s not generating enough cash. In the latest 12 months through Oct. 28, 2023, its cash flow from operating activities was -$33.9 million. At the end of fiscal 2021, it was $133.3 million.
To fix this, it obtained a $130 million term loan in February with a Nov. 15, 2026 maturity, at an interest rate of 14.3%, or SOFR (Secured Overnight Financing Rate) plus 9%.
Then, Mithaq Capital, which controls the company through its 56.1% ownership stake, provided $78.4 million in interest-free, unsecured, and subordinated term loans.
Now, not only does it have a stronger balance sheet, it has a controlling shareholder who has a vested interest in its success. To ensure this happens, Mithaq has added four board members, including Chairman-elect Turki Saleh A. AlRajhi, the head of Mithaq Capital.
The Value Trap
Are you familiar with the Altman Z-Score? It’s a financial metric developed by NYU Professor Emeritus of Finance Edward Altman in 1968. It’s a numerical measurement that predicts a company's chances of going bankrupt.
I won’t get into the specifics of the formula. However, the metric suggests that companies that get a score of 1.8 or less have a good chance of going bankrupt over the next 24 months. Anything between 1.8 and 3.0 has a moderate chance of bankruptcy, while those over 3.0 are unlikely to go bankrupt in the next two years.
In 2018, the year PLCE hit $160, its Altman Z-Score was around 6.77, more than twice what’s needed to avoid bankruptcy. Today, based on its Oct. 28, 2023, results, it’s 1.56, putting it in the distress zone under 1.8. Once the company delivers its audited Q4 2023 results, that score will move lower.
Given the significant possibility of bankruptcy in the next two years, one could argue that PLCE is overvalued even at a $165 million market capitalization. At the height of its success in 2018, its market cap was 14x what it is today.
However, its total debt in 2018 was 18% of its market cap. Today, it’s 405%. Any valuation metric in 2018 would have looked better than it does today.
If it weren’t for the lifeline of its controlling shareholder, I would recommend investors stay away from PLCE. The fact that it has suggests that it has a more extended play in mind than just boosting its share price to make an excellent return on its activist investment.
Although it purchased 1.23 million shares of PLCE on Feb. 9 at prices between $8.52 and $9.99, it also purchased nearly 200,000 shares on Feb. 7 for prices as high as $18.88.
Once news got out that Mithaq had taken control of Children’s Place on Feb. 15, its shares jumped by more than $23 to a high of $38.01 before falling back to earth.
That spike has meme-stock written all over it. However, now that it’s back below $14, aggressive investors might want to explore taking a position. PLCE hasn’t traded this low since the early 2000s.
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
