Watching for a Weird-Weather Whipsaw at Children's Place

The apparel seller got hit by a cold snap just as it put its spring clothes on the racks.
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It's about 15 degrees outside Manhattan's World Trade Center, and passersby are bundled up against the swirls of snow. But at the

Children's Place

(PLCE) - Get Report

inside the mall, spring has arrived. The store is a flurry of little pastel jumpers and tiny flowered T-shirts; the only vestiges of winter wear are a sale rack or two of polar fleece.

That mismatch of clothing and weather, say two short-sellers, could mean trouble for the specialty chain when it reports quarterly sales and earnings next month, particularly on top of tough comparisons with year-earlier figures. (CFO Seth Udasin referred questions to an outside spokeswoman, who said the company wouldn't comment on its current business activities.)

Children's Place shares have already been beaten up plenty this year, falling 74% from their July high. Wednesday's 12% retreat put them at a 52-week low of 12 1/2. But the shorts aren't covering yet. If the company disappoints, shares could fall further, they contend.

Gallows Polar Fleece?

Earlier in the quarter, Children's Place loaded stores with brightly colored polar fleece. Analysts praised the lineup, but the weather didn't cooperate: The late fall and early winter were unseasonably warm, prompting big markdowns to move product. (Kids' clothing isn't the kind of thing parents buy and hold, since children may outgrow it by the time they get to wear it.) At the same time, rival

Gap

(GPS) - Get Report

was also marking down its clothes, putting pressure on Children's Place to do the same.

No Kidding Around
Noting a distinct downtrend at Children's Place

Source: BigCharts

The company also put out a preholiday promotional mailer advertising 25%-off discounts to "control inventory," according to a spokeswoman. That was in addition to its annual "Monster Sale," which offered discounts of 50%. "That 25% off killed margins," says one short-seller.

And then came the cold and snow -- at just about the time Children's Place had filled its stores with spring goods. The result, say the shorts: a possible hit to sales, and more likely, to margins. Children's Place is set to report fourth-quarter sales Feb. 3 and fourth-quarter earnings Feb. 24. Investors punished

Bebe

(BEBE)

last week after the company reported a greater-than-expected jump in fiscal second-quarter earnings but said gross margins had fallen and may continue to do so. Its shares have since fallen 24%.

Spring Cleaning

Short-sellers aren't the only ones worried about Children's Place. "I'm a bit concerned," says a sell-side analyst who rates the stock a buy and didn't want to be identified. "They transitioned more significantly

to spring than others did." But the analyst went on to outline two longer-term benefits of Children's Place: its positioning as a cheaper alternative to

GapKids

,

Talbots'

(TLB)

Talbots Kids

and

Gymboree

(GYMB)

, and its potential to expand from its current base of 293 stores to the West Coast. Most analysts who cover the stock rate it a buy.

One of them is Harry Ikenson, of

Chase H&Q

, who says he hasn't changed estimates because of any concern about weather. "Is it optimal? No," he says. "But January is a small month

for sales anyway." (His firm has done recent underwriting for the company.)

The shorts say that GapKids can afford to keep its eye on Children's Place and promote its own similar -- but higher-quality -- merchandise. And expansion plans can come to an abrupt halt if a retailer runs into a wall and operating costs outpace margins.

Turns, Turns, Turns

This wouldn't be the first speed bump for Children's Place. After its 1997 IPO, it faced a shareholder lawsuit after missed earnings sent its stock down. Its shares recovered, reaching almost 54 on July 15. But shares fell again last year amid interest-rate concerns and worries that same-store sales growth was slowing. In August, shorts

raised questions about the company's quality of earnings, including increasing inventory turns and declining inventory yield -- which can signal slower sales and lower profit. At the time, CFO Udasin said declining inventory turns came from a new strategy to hold product at distribution centers for a longer time before shipping it to stores.

Short-sellers also note that in September the company said it would withdraw its proposed secondary offering, saying its value wasn't reflected in its stock price (then about 34). Later that month, though, two other insiders sold shares accounting for 3% and 17% of their respective stakes. "What kind of message does that send?" asks a short. Through a spokesman, the company said that the executives had a limited time to sell shares and meet a margin call. Personal reasons were also a factor, he said.

At their current price, Children's Place shares are certainly cheap, trading at just 11.5 times fiscal 2000 earnings. The shorts, however, are betting that they're cheap for a reason. And if they're right, February may be a bumpy month for the company. "They can't afford to miss," says one short.