What happens to a stock when its company's biggest rival goes bankrupt? According to Wall Street, it goes down.
That was the case earlier this week when news broke that Gymboree, the biggest direct competitor of Children's Place (NASDAQ:PLCE), would file for bankruptcy.
Shares of Children's Place, the largest pure-play children's specialty apparel retailer in North America, fell 4.5% on Jan. 15 as news broke that Gymboree would file for Chapter 11 for the second time in less than two years; it was expected to close around 800 stores in total. On Jan. 17, when Gymboree actually filed for Chapter 11, the company said it would close its Gymboree and Crazy 8 stores, and attempt to sell its 139-store high-end Janie & Jack chain, as well as Gymboree's intellectual property and website.
The market's reaction to the news, selling off Children's Place stock and pushing it to a two-year low, can only have one of two reasons. First, investors fear that short-term performance will be impacted by liquidation sales at Gymboree, something Children's Place acknowledged in its third-quarter earnings report when it lowered its full-year guidance. The other possible reason is that the market sees Gymboree's bankruptcy as a red flag for the broader children's-apparel retail sector, as brick-and-mortar stores have been challenged in recent years. However, this line of reasoning makes little sense as Children's Place is in a much stronger position than its bankrupt rival. Children's Place reported comparable-sales growth of 9.5% in its most recent quarter, and the company is solidly profitable with an 8.6% operating profit margin in its most recent fiscal year. Children's Place has also built a strong e-commerce program with 29% of its revenue coming from the online channel, showing e-commerce has been a source of growth for the company rather than a threat.
A brief history lesson
There have been plenty of retail bankruptcies in recent years as several chains have been pressured by changing consumer habits and the rise of e-commerce, especially of Amazon (NASDAQ:AMZN). The record on how surviving competitors performed is mixed, but there's little evidence that competitor bankruptcies are bad for other industry operators. Let's take a look at a few cases.
Dick's Sporting Goods (NYSE:DKS), the country's leading sporting-goods retailer, has weathered a wave of competitor failures in recent years, including The Sports Authority, Eastern Mountain Sports, Gander Mountain, City Sports, and Bob's -- ample evidence that the industry was oversaturated. After Dick's stock rose in 2016 on anticipation that it would capitalize on those opportunities, which included taking over stores from Sports Authority, it plunged 45% in 2017 as Dick's performance did not meet expectations and sales growth was underwhelming. Today, Dick's remains stable and profitable, but the stock has not recovered from the 2017 slide and is trading near five-year lows.
Best Buy (NYSE:BBY), on the other hand, has been an undeniable success story despite considerable pressure on electronics retail over the years from Amazon and others. While competitors like Circuit City and H.H. Gregg have fallen by the wayside, Best Buy found a way to thwart the showrooming effect with a combination of price-matching, better customer service, shop-in-store formats, and a focus on services with the help of Geek Squad. As a result, the stock has more than quadrupled since it hit bottom at the end of 2012, when "showrooming" worries peaked. Best Buy remains healthy today, with comparable sales up 4.3% in its most recent quarter, and adjusted earnings per share increasing 19%.
Finally, when Borders filed for bankruptcy in 2011, many thought that Barnes & Noble's (NYSE:BKS) days were numbered. The stock slipped below $10 for the first time ever that year, but the bookstore chain has bucked expectations that it would go belly-up. While Barnes & Noble stock has continued to struggle (it trades around $6 a share today), the company continues to operate more than 600 stores nationwide, embracing toys and games to support the buffeted book business, and even saw solid growth during the holiday season as comparable sales jumped 4%. It's also opening new small-format, community-focused stores. On a GAAP (generally accepted accounting principles) basis, B&N isn't profitable, but it's targeting $175 million to $200 million in EBITDA (earnings before interest, taxes, depreciation, and amortization) profit for the current fiscal year. While the bookstore chain is hardly thriving, no other company has faced the wrath of Amazon more than Barnes & Noble. That it is still operating hundreds of stores today, and even opening new ones, shows that expectations of its demise after Borders died were wrongheaded.
What it means for Children's Place
There are no perfect analogies in business, but it's hard to conclude from the above stories that a rival's bankruptcy is a bad thing for a surviving retailer. It may not necessarily be a boon, as evidenced by Dick's struggles. But Children's Place is in a stronger position than any of the retailers above at the time their competitors went out of business, so it's better prepared to capitalize on Gymboree's faltering. In December, when Gymboree said it would close a significant number of its stores, Children's Place said in its following earnings call that it was targeting $100 million in market-share gains. With nearly all of Gymboree's stores now closing, that number could double.
While some short-term headwinds due to liquidation sales are expected, a year from now Children's Place will likely be in a stronger position thanks to Gymboree's exit. With the stock already looking cheap and a number of other initiatives underway to further improve the underlying business, the Gymboree-inspired sell-off in Children's Place stock looks like a mistake.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Amazon and The Children's Place. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.