The Long Case for Hanes: Buy What You Wear

I have a favor to ask all of you folks out there in the civilized world, "please, raise your hands if you wear underwear!" Yes, you heard me right, and I really don't care what you call it: undergarments, lingerie, bikinis, knickers, fundoshis, bras, briefs, knickers, g-strings, unmentionables - they are all still underwear. Now, don't be shy - let's see that show of hands... Did I just see almost 6 3/4 billion hands go up? I think so! Short of a few teenagers, several hardcore nudists, a few native Tahitians and a number of other French-speakers, everyone wears some sort of underwear just about every day of their life. Wow, everybody - that's a lot of potential customers. I like that!

So, who makes all this underwear for the world? Common, I challenge you to name the top three companies in the underwear business. I know that you know them. Yes, that's right, they are Fruit of the Loom, Hanes and - this may take a little head scratching - the privately owned Jockey.

But are there others? Sure, there are plenty of other undergarment brands out there. Under hypnosis or through a little meditation, most of us could probably access our deep hidden memories and start to recite a long list of underwear brands: Victoria's Secret, Speedo, Playtex, B.V.D., Calvin Klein, Tommy Hilfiger, Hugo Boss, Liz Claiborne, and the list goes on...

Sounds like this undergarment industry is rather fragmented, doesn't it? Sure does, until you realize that many of the brands are owned or licensed to the the same majors and the ones that are not, are rather small niche players. Once you sift through the long list of names and verify their retail availability, the picture gets much clearer, at least in the US, where you would be hard pressed to find a significant presence at Wal-Mart (WMT), Target (TGT) and Kmart (SHLD) by any brand of underwear that is not distributed by Hanes or Fruit of the Loom, unless it is a store brand, of course.

Fruit of the Loom is wholly owned by Berkshire Hathaway (BRK.A), which owns a whole slue of other companies and is heavily in the insurance business - definitely not an underwear pure play. That leaves only Hanes Brands, Inc., a 2006 Sara Lee spin off, if you wanted to play this lucrative non-discretionary apparel category.

Luckily, Hanes Brands, Inc. (HBI) is not only the largest independent underwear maker, but also is big enough to have the economies of scale to compete with store brands on price. Yet, on Friday, December 12, 2008 it was trading at less than 5 times average estimated 2009 earnings! Note that even with today's sad state of the economy, Hanes Brands, unlike most other apparel makers, is and will continue to make money.

So, why is it then that Hanes Brands, Inc. is trading at such an attractive price level? There are a few good reasons for this:

1. Hanes was spun off by Sara Lee (SLE) with lots of debt and while Hanes has done well to pay some of it off, it is still more leveraged than most others in their industry. In today's environment, where cheap credit has dried up, this is foremost on investor's minds. However, through the inflationary efforts of US and other world governments this situation will change sooner than most people now realize and in the meantime, Hanes has plenty of cushion on the leverage ratio required by its lenders. According to Credit Suisse, HBI's 1Q09 EBITDA would have to fall 80% for the covenant to be violated and not even the most pessimistic of pessimists expect anything like this to happen.

2. While the price of cotton fell precipitously with other commodities in the second half of 2008, HBI's cotton costs will remain rather high into 1Q09 at 73 c/lb. Cotton is a major input cost for Hanes and this price is more than 30c/lb higher than the current spot market price fro the commodity. This will definitely put short term pressure on Hanes' margins. This, however, is a very short term effect and by Q2 margins are expected to expand significantly, as lower cotton prices along with February 2009 price increases hit the books.

3. HBI has traded independently from its Sara Lee mother for only two years. During tough economic times, many investors tend to prefer companies that have public histories covering multiple economic cycles. Hanes Brands, of course, does not have such a history, so when their apparent competitors like Gildan (GIL) warn on profits, Hanes shareholders get very nervous and dump. Fortunately, HBI's product mix and market presence is far more recession proof than Gildan's. Also, if sales do dip beyond expectations, Hanes is in a good position to cut discretionary costs in a way that would result in a minimal impact on the quarterly income statement.

After contemplating and sleeping on the facts in my Hanes briefs, I pressed the buy button on Friday, December 12, 2008. I ended up with shares of Hanes priced at $10.61. So, here is my message to all of my blog readers, whether you be an investor or a shoplifter - buy what you wear!

Disclosure: Long

Comments

[Al Bino:]

Anyone that invests in Hanes will lose their money. Once hanes cuts all their people and plants, where can they go. Bad investment. The management just can't figure it out.

2008 Dec 15 11:58 AM

[Jake Berzon:]

This morning I closed my Hanes Brands, Inc. (HBI) position at $13.19 for a gain of 24.3% (excluding commissions) in under a week. As much as I would have liked to have ridden out further gains in this stock to perhaps a $15+ range (my estimate of this stock's true current value), taking reasonable gains, when a position appreciates quickly, has proven to be a prudent strategy in today's fast moving and rather unpredictable market environment.

2008 Dec 18 10:52 AM