Hanesbrands: Low Dividend Yield, But Record Cash Flow Could Mean 35% Upside

| About: Hanesbrands Inc. (HBI)
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Hanes is gearing up for what’s expected to be a solid holiday season by leveraging social media influencers to keep its brands in consumers’ minds.

Unlike other stocks in its sector, Hanes is expecting solid revenue and earnings growth in 2016 and has also taken steps to position itself for 2017.

Hanes dividend isn’t particularly attractive, we believe that the stock is nearly 35% undervalued and that patient investors should be buying the stock ahead of its next earnings report.

Hanes Gearing Up for Holiday Season

In a year when Hanesbrands (NYSE:HBI) expects its net sales to grow by as much as 9%, the innerwear maker is certainly looking forward to strong holiday sales to ensure that it meets its guidance to investors.

One early initiative from Hanes was its hiring of a known celebrity stylist as a brand ambassador for its Maidenform brand. The stylist's strong social media presence and celebrity clientele are meant to appeal to keep Maidenform in customers' minds as they go about their holiday shopping.

As a company, Hanes has had considerable success in using celebrity endorsements to build its brand - notably with basketball icon Michael Jordan, who remains an endorser of its flagship Hanes brand to this day (in fact, Jordan's image is on Hanes' Investor Relations page). In that sense, Maidenform's recent move, while certainly on a much lesser scale, follows in that tradition.

One aspect of Hanes that may make it attractive to investors is that, unlike other apparel brands that are subject to shifting consumer tastes and fashions, many of its products are innerwear and clothing that are essentially consumer staples. That is, while consumers may reduce spending on higher-priced clothing, they will continue to spend money on underwear and innerwear.

This is evident in the 8% sales growth that Hanes sees for the year, in contrast with the slower - or even negative - revenue growth rates for more economically-sensitive stocks such as Gap (NYSE:GPS) or Ralph Lauren (NYSE:RL). This quality could potentially qualify the stock as a long-term portfolio holding but, even so, investors should be conscious that the stock is still lumped together with apparel stocks, which contributed to Hanes shares' 16% slide for the year (in addition to its lowered earnings guidance between quarters).

Another aspect that investors may find attractive is Hanes' dividend which, at 1.78%, is around 30-basis points better than its peer group's average yield. That being said, it is around 40-basis points lower than the yield of the S&P500 and investors should take note of this when making their evaluation. Regardless, investors who buy $10,000 worth of Hanes shares can expect to receive $178 in dividend checks a year after holding the stock.

Given the above, should dividend-focused investors consider adding Hanes to their portfolio? Let's take a look.

The Power of Vertical Integration

As we've mentioned, Hanes sees relatively decent revenue growth prospects this year and while its first half sales were slightly lower (-1.4%) than a year earlier, Hanes' management noted that its first half sales were right in-line with the company's expectation for the period. Considering this, we don't see downside to Hanes' forecast of 7% to 9% sales growth for the year and an expected strong holiday season for retail - plus the consolidation of the parts of Champion brand it didn't already own before - should allow it to achieve these results. In any case, beyond sustaining its current brands, Hanes is likely to continue pursuing a growth-by-acquisition strategy, as it outlined in a briefing to investors earlier in the year.

Historically, Hanes has hewed closely to its core product lines such as innerwear and athletic apparel - Maidenform, Knights Apparel and Champion Europe all fit in this profile - so any future acquisitions are likely to be in complementary fields, which bodes well for its ability to integrate these future acquisitions and to mine these acquisitions for cost-efficiencies.

One aspect that investors should be paying attention to is Hanes' vertically-integrated operation. As its disclosures state, close to two-thirds of its goods are manufactured in factories it owns (with some partner manufacturers only performing intermediary steps such as sewing) - but rather than operating these factories in high-wage markets like the United States, Hanes operates factories in emerging markets where labor and input costs are lower.

Consequently, while Hanes sells goods such as briefs and t-shirts that have lower margins than designer coats and trousers, its EBITDA margins are actually on-par with the rest of its industry. Moreover, while its operating margins are less (due to the depreciation 'hit' from owning its own facilities), its pre-tax margins are actually between 100-to-140-basis points better than its peer group's.

Plenty of Capital

Hanes' strong financial position should help it continue paying dividends to shareholders. To wit, the company anticipates record operating cash flow of between $750 to $850 million this year, which should help buttress its already strong liquidity position of $2.34 in working capital for each dollar of short-term liability. All else being equal, Hanes' expected operating cash flow for 2016 is equivalent to 5 years' worth of its dividends.

Investors should note, however, that Hanes is a bit more highly leveraged than its peer group with nearly $3.60 in debt for every dollar of equity. Part of this is due to Hanes' leveraged recapitalization: the company had net borrowings of $1.15 Billion in the first half of 2016 even as it repurchased nearly $380 million in shares. In short, Hanes has been returning money to shareholders and financing these returns through debt. However, given Hanes strong brand portfolio, robust cash flow and solid liquidity, we do not foresee any credit concerns for the company.

A Steep Discount

Hanes shares are currently trading at a shade under 20-times earnings - a discount to the nearly 25-times earnings multiple of the S&P500. Hanes is anticipating a mid-point of $1.92 in adjusted earnings per share for the current year, which implies that it's trending towards a 12.85-times earnings multiple. Our own view is that Hanes' actual results will hew towards the midpoint of its guidance, which is in-line with the consensus.

Looking ahead to 2017, we see Hanes' latest acquisitions and a moderately stronger economy buttressing sales and earnings and anticipate 15% adjusted earnings growth to $2.22 per share, which is moderately higher than the consensus estimate. This would imply an 11-times earnings multiple, which we believe it too low for a company whose earnings are growing by double-digits. Other stocks in the apparel sector are trading at 19-times forward earnings and we expect to see a compression in this gap - to around 15-times earnings in Hanes' favor. Thus, our target price for Hanes is $33 per share, which is slightly below the consensus target price of $33.91 per share.


Our current target price, which builds on conservative assumptions regarding Hanes' earnings growth, implies nearly 35% upside for the stock - making it greatly undervalued - and we believe that patient investors will be rewarded by buying the stock today.

While it's certainly true that Hanes' dividend is below the average for Large Cap stocks, our upside view and its dividend yield mean that investors are looking at a nearly 37% total return on Hanes' shares. We believe this is an especially solid return for a solid company that is better-equipped to handle economic weakness than its peer group.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HBI over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.