If you’ve had a baby or welcomed a grandchild in the past few years, there’s a goodchance you’re familiar with Carter’s and a decent chance you’ve spent money with them.Carter’s is the largest maker of clothes for babies and toddlers, selling clothes and babygear under its eponymous Carter’s brand and the OshKosh B’Gosh brand.I find the transformation from raw cotton to “Hey, that’s a cool shirt,” a bit magical. Thereare the purely functional aspects of weaving and dyeing, but the designing and brandingof the product is what can create above-average economic returns for a long period oftime. Since 1865, Carter’s has done this better than anyone else in the baby apparelbusiness. The company has been careful to attune its designs to current trends, withoutbeing trendy, and is a primary source of basics, like one-pieces and t-shirts, a strategythat makes it less likely that its appeal will go out of style.In addition to selling to department stores, Carter’s operates over 300 of its own brandedstores across the US, which is much less than its full potential. Each new store it opensdraws in more new customers, a positive indication of its future earnings potential. It onlyrecently started selling clothes through its website, and the early results are promising. Idon’t expect Carter’s to grow its revenue at the same 14% compound annual rate it grewover the past 10 years, but it should grow faster than the US economy as a whole.Ashort-term problem that Carter’s faces is abnormally high cotton prices, which hasincreased Carter’s costs. Over the past 30 years, cotton prices have averaged about 70¢per pound, but shot up to as high as $2.30 per pound earlier this year, a 140-year,postbellum high. Some investors like to talk about “commodities” as a single entity orinvestment class, but cotton is not like oil or natural gas: There is not a fixed amount ofcotton in the ground that we are using up every day. When people use more cotton andprices go up, farmers plant more cotton. It takes time for cotton to grow, and thus a whilefor the market response to impact prices. There was indeed a temporary shortage ofcotton that caused a price spike, but I strongly suspect it was exacerbated byspeculation.
The Wall Street Journal
reported in January that cotton farmers in ruralChina were filling their homes with their entire cotton harvests, hoarding in the hopes ofseeing prices go up even further, to me an indication of a speculative bubble. Thisbehavior can distort short-term prices, but the fundamental supply and demand for cottoneventually determine market prices. Since March, cotton prices have receded sharplydown to $1.05 and look to be going lower.When Carter’s announced that high cotton prices would cut into its earnings for the restof the year, many investors sold their stakes in the company, giving the fund anopportunity to add to its existing position, an opportunity only because of our longer-than-average time horizon. This investment is in the sweet spot for the Bretton Fund: a greatbusiness facing a temporary problem.
In the period since March 31, the fund made one new investment: The Gap, anotherpurveyor of apparel, whose brands include Banana Republic, Old Navy, Piperlime, andAthleta. The investment case for The Gap is similar to that of Carter’s, but Gap does notneed to grow its appeal or number of stores for our investment to turn out well. Thecompany’s share price is so low compared to its normalized earnings (most of whichmanagement distributes to shareholders), that even if it doesn’t grow its revenue at all,we’ll do just fine.
2011 Semiannual Report 2