Investing In Underwear: Hanes Is 29% Undervalued

| About: Hanesbrands Inc. (HBI)

Summary

Price decline from 2015 in HanesBrands offers value.

Cheap debt is fueling earnings growth.

Dividends are growing quickly since inception in 2013.

Discounted Cash Flow suggests 29% upside.

HanesBrands, Inc. (NYSE:HBI) caught my attention when I saw it trading in the low $20's. I don't often get excited about underwear, but below average multiples, earnings growth, and a discount to intrinsic value changed that.

Valuation

At $22 per share, Hanes trades at a P/E of 12.9 on a TTM basis and a P/E of 11.6 for the current year's estimates of $1.90 per share. Historically, the company traded at an average (10 year) annual P/E of 15.5. The five-year average is 14 times earnings. Figure 1.1 below illustrates where the earnings multiple has been against the 10 and 5 year averages.

Fig 1.1

Source: Adapted from Value Line data

The P/E using the last four quarters implies HBI trades at a 17% discount to its five-year average (11.6 vs 14.0.) The P/E was this low back in 2012 when the stock traded between $6-9, which ran up to $33 in 2015.

Recent acquisitions like Knights Apparel, DBApparel, and Pacific Brands will drive sales. Because Hanes owns the majority of its production facilities and has a cost-efficient supply chain they are capable of increasing margins on these businesses to meaningfully impact the bottom line.

Debt

Long-term debt increased from $2.4 billion a year ago to $3.7 billion in the most recent quarter. This pushed the total debt/ equity ratio to 3.1 - the highest it has been since the crisis. Figure 1.2 below shows their loans stated in the last 10-Q. With a weighted-average interest rate of about 3.8% and a cost of capital of around 6%, they are acquiring companies with IRR rates in the mid-teens (according to figure 1.3 from their presentation.)

I expect over $500 million in free cash flow per annum going forward (you can take a look at my DCF below - to note, I assume a normalization in CAPEX) which gives us a debt-to-FCF of about 7.4. This is conservative given the company expects FCF of $800 million. Unless underwear goes out of style, I do not think HBI is too highly levered. Most of the debt is due in the next ten years and HBI has a BBB credit rating with Moody's. The investment-grade debt implies they should not have a problem refinancing if needed.

Liquidity ratios provided by Morningstar are stable:

  • Current ratio = 1.90
  • Quick ratio = 0.75
  • Accounts payable, short-term debt, accrued liabilities are higher but not out of line with historic figures

Fig 1.2

Source: SEC filings

Growth Opportunities

The average analyst EPS growth rate is 15% for 2017. Hanes has seen earnings growth of over 20% over the last five years and low-to-mid double digit growth is expected. Assuming a 15% EPS growth rate, the implied PEG ratio is 0.77. This is highly attractive; it is rare to find a cheap growth company with a sustainable business.

Hanes is able to achieve this from a few different factors:

  • Acquisitions add materially to their sales and profits (Figure 1.3).
  • The self-owned supply chain and manufacturing capabilities has allowed for margin expansion (net margin has increased from 6% five years ago to 12% today; operating margin has expanded from 12% five years ago to 17% today.) Figure 1.4.
  • Synergies from acquisitions, incorporation into supply chain leads to margin expansion and solid earnings growth.
  • 80% of sales are domestic while they are positioned around the globe. Europe, the Pacific Rim region, and South America are key markets going forward.
  • Higher-margin products like activewear and additional brands that have pricing power are being incorporated into their business model.

Fig 1.3 - Investor Presentation

Fig 1.4 - Feb. 2016 Investor Presentation

Yield

Hanesbrands started paying dividends in 2013 at $0.15 per share and is now $0.44 per share. The stock currently yields about 2%. The dividend is below that of the S&P 500 yield but is growing faster. As debt gets reduced on the balance sheet I expect Hanes to continue to raise its dividend - to note, the payout ratio is under 25% currently. Given its short history, I am encouraged by management's decision to pay and raise dividends. Year over year, they were increased "only" 10% from $0.40 to $0.44 - look for another 10-15% raise in 2017.

DCF Valuation

The company has a 29% upside according to my DCF model. I attached my core assumptions below. It is realistically conservative and does not factor any continued increasing margin efficiencies.

Source: Adapted from Morningstar data

Thesis

Hanesbrands is a worthwhile consideration at the current price. It has not found a bottom yet from its decline but the company looks fundamentally sound. Though levered, the company has a decent yield, attractive valuation, good growth, and real upside from the current quote.

Supporting Documents

  1. HBI_-_Sheet1.pdf
  2. HBI_Investor_Presentation_February_2016_FINAL_full...

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.

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