M) and Kohl's ( KSS). Special-brand lines were developed for Wal-Mart ( WMT - Get Report) -- the "Child of Mine" brand -- and Target ( TGT) -- "Just One You" -- representing about 20% of sales. Additionally, Carter's operates 289 self-branded locations and an additional 175 OshKosh stores. OshKosh (acquired in 2005) is the firm's older-age brand, while Carter's focuses more on newborn and infant clothing. While several retailers occupy the Magic Formula screens at present, Carter's has some interesting characteristics that may make it a more attractive play than others. For one, children's clothing is a less-volatile business than standard apparel. While adults will bargain-shop in a recession and teens are constantly changing fashion allegiances, parents and grandparents usually do not put a lid on spending for the little ones, and fashion is a lesser concern. This helped the children's apparel market fall less severely during the 2008-2009 recession -- a 3.5% decline vs. 5.1% in general apparel, according to NPD. Demographic trends are also favorable. The U.S. is in a mini "baby boom" right now. More babies were born in 2007 than in any year in the country's history, and the 2000-2009 period was the highest decade for births since the 1950s, by far. Combine this with those 1950s babies becoming grandparents, and the situation is ripe for organic growth in spending on children. Carter's is well-positioned to benefit. Same-store sales growth has consistently been in the mid- to high-single digits over the past several years. On an operational level, Carter's has plenty of avenues for growth. With 464 stores, many analysts believe there is expansion potential to 600 or more locations. Consider that competitor Children's Place ( PLCE) has more than 950 stores and Gymboree ( GYMB) about 650, and the ultimate potential may be even higher. Carter's has solid financial characteristics. Cash and debt balance out, at $245 million and $232 million, respectively. The company pre-paid $100 million in debt in June, further strengthening its position. Operating margins after subtracting one-time charges have been good, in the 10% to 13% range. They have been particularly strong recently, with trailing 12-month margin at 15%. Free cash flow margins are 8% to 10%, high for a retailer, and return on capital is excellent at 20%.
There are some risks here. Several big-chain retailers have been looking to move to private-label clothing to improve their margins. Wal-Mart's floor-space reduction for Child of Mine has hurt, with the line posting a 47% sales decline in the most recent quarter. Carter's recorded its first same-store sales decline in three years for the second quarter, fueling concerns that competition such as Gymboree's Crazy 8 stores are hurting traffic. Finally, there seems to be some lingering concern over past management blunders. Carter's had to restate earnings last year due to accounting missteps, and it also wrote down $155 million in goodwill from the purchase of OshKosh after continued poor performance. That is almost half the purchase price of $312 million, indicating significant overpayment. Overall, though, Carter's looks like an attractive Magic Formula investment. At about $24, the stock's adjusted earnings yield (EBIT/EV) is 17.4%, well above its five-year average of 10%. Taking into account 2011 projections, modest growth rates, and historical multiples, a good sell price for the stock is about $35, a 46% increase from current trading levels.