2023-06-14 03:44:59 ET
Summary
- Hanesbrands' issues continued into Q1 as expected, with some green shoots of improvement.
- Reducing inventory is priority #1, as that will help gross margins and flow into its ability to reduce debt.
- HBI stock remains a "buy" for aggressive investors.
Back in March , I wrote that Hanesbrands ( HBI ) has problems but that they are fixable. Since that time, the stock is down a little over -10%. Let's see if the company is making any progress with fixing its issues.
Company Profile
As a quick reminder, HBI is an apparel company focused on undergarments and activewear. While it owns a variety of brands, Hanes and Champion are its two largest. Hanes focuses on basic everyday apparel items such as underwear and t-shirts, while Champion is known for its athleticwear, particularly its mesh shorts and practice uniforms.
The company primarily sells its products through wholesalers, and over 70% of the apparel it sells it manufactures at its own facilities or dedicated contractors. Under 20% of its revenue comes from the DTC channel.
Q1 Progress
2022 was a terrible year for HBI, as management misread its growth drivers from the prior year and didn't realize wholesalers were stocking up on inventory due to prior Covid-related supply chain issues. HBI wasn't the only firm to see this happen, and it was a pretty common occurrence in the apparel industry and even with other consumer-facing companies.
However, HBI was particularly hard hit, as not only was inventory too high, but the company also runs its own manufacturing facilities. While vertical integration has its benefits, it also has its downsides. When the wholesale channel is stuffed with inventory, manufacturing facilities certainly aren't able to run at full utilization. Thus, there is a double whammy on margins.
HBI's issues were expected to persist through at least the first half of 2023, and in a vacuum its Q1 results certainly were not good, although they were never going to be good and they did top expectations.
Looking at inventory, the company was able to reduce inventory by -1% sequentially to $1.97 billion, although inventory was still up 8% year over year. HBI said it has reduced its SKU count by 45% from the peak, and is focusing on the main items that drive its business. It also noted that destocking is largely behind the company.
For innerwear, the company thinks its inventory is in pretty good balance, with POS and shipments matching up pretty well. Champion and the activewear category remain more difficult, with the inventory in the wholesale channel still needing to be cleaned-up and some slower consumer spending.
On its Q1 earnings call , CEO Stephen Bratspies said:
Innerwear is certainly balanced out faster than Activewear has, and there are a lot of reasons for that. I mean it's a different business, different channels, different competitors. So we're seeing it start to balance out, Jay, but I think it's going to take a little bit of time for us to work through that. And that's going to really drive by the consumer and how much they start to kind of re engage with the category. It has not gotten super promotional in our space. But I think it's going to take some time for that to balance out as we go forward. And we're watching it closely. I mean, you can see in our results, we had a little bit of higher E&O expense in the Activewear space in this quarter than we had initially planned. So we're watching it closely."
Not surprisingly, the current situation continued to put pressure on margins. Adjusted gross margins of 32.7% fell by -440 basis points year over year. However, HBI noted that input costs have come down significantly, with cotton costs down -25% and freight -40% lower. Once it runs through higher-priced manufactured items, gross margins should improve significantly, with Q4 projected to see a meaningful improvement.
HBI's debt level is another big issue the company faces. On that front it ended the quarter with leverage still elevated at 5.4x. Reducing inventory helped the company generate $45 million in operating cash flow in Q1, which is usually a period where it sees cash outflows. HBI is still projecting OCF of ~$500 million for the year. The company plans to use all its free cash flow to pay down debt this year.
Valuation
HBI currently trades around 9.6x the 2023 consensus EBITDA of $598.8 million and about 8.1x the FY2024 consensus of $708.2 million.
It trades at a forward PE of 15.3x the 2023 consensus of 31 cents and 6.4x the 2024 consensus of 74 cents.
Revenue growth is expected to be -3% this year, and then grow over 2% in 2024. Margin improvement is thus the biggest driver of EPS growth from 2023 to 2024.
If HBI can reduce its debt by ~$1 billion by the end of 2024, then it may only be trading at 6.7x 2024 EBITDA, which for a brand is pretty attractive. The company has often seen between a 10-12x trailing multiple in the past.
Conclusion
Cleaning up its inventory issues remains job #1 for HBI. It's progressing on the Hanes brand, but Champion appears to be more of a challenge. The inventory at Champion will get cleaned-up, but whether the brand can fully recover to where it was a couple of years ago is a question mark. The brand found renewed popularity a few years ago, but that has started to wane, and there is no guarantee its sales will go back to where they were. A Champion recovery this year or next aren't really in estimates, so it is a bit of a free call option.
Job #2 is to reduce its debt load and take leverage down. Taking net debt down to $3.0 billion will still only get its leverage down to about 5x. If it is able to get it down to $2.5 billion by the end of 2024 and generate $700 million in EBITDA, then it's at a more attractive ~3.5x.
Getting to $700 million in EBITDA will largely come from margin improvement, which will come as a result of fixing its inventory issues. As new products with lower input costs flow through the system, its margins will get a nice boost.
Thus, I still maintain that HBI's issues are fixable, but it certainly will not happen overnight. Reducing inventory remains the most important thing, and that will also help its debt level issues as well. While not for the risk adverse, I continue to think HBI is a buy for aggressive investors.
For further details see:
Hanesbrands: Reducing Inventory Is The Key To A Turnaround