Hanesbrands: I'm Buying The Dip
Summary
- Global direct, international, and Champion growth continued, driving overall revenue growth (including constant currency organic growth) during Q2.
- Management reaffirmed full year guidance and long-term Champion growth guidance.
- The market overreacted to Target failing to renew its C9 by Champion contract in 2020, making shares highly attractive.
- At a time when massive distortions in the economy are likely leading to malinvestment, investing in a discounted, defensive consumer goods business with strong liquidity and a healthy dividend is prudent.
I am buying Hanesbrands (NYSE:HBI) following the market sell-off of shares because the reaction to Target's (TGT) non-renewal of its C9 by Champion contract in 2020 is overblown and the business is just now entering its rebound stage where management's growth strategy should begin bearing fruit.
Safety
The company's moat (defined by its global supply chain, economies of scale, and brand power) remained strong during the quarter. According to studies cited by management on the earnings call, brands in this category of consumer goods are just as important to customers today as they were 5 years ago and HBI management continues to invest heavily in maintaining and strengthening their brands.
Furthermore, while not immediately evident in this quarter's results, management pointed repeatedly during the Q&A to the role that their increasing economies of scale/synergy harvesting and ability to mitigate/pass on inflationary costs to their customers through their supply chain and pricing power with retailers will play in driving margin expansion beginning in Q3. While inflationary pressures across all production and transportation categories squeezed margins in the first half, the company is leveraging their pricing power with retailers to raise prices, which should combine with increased efficiencies from Project Booster to expand margins.
The company also continued to progress on its deleveraging efforts, reducing net debt by ~$52 million during the quarter despite the declining margins. They should be able to make much more rapid progress in the second half as cash flows pick up through increasing growth and margins.
Growth
Global direct, international, and Champion growth continued, driving overall 4% revenue growth (including constant currency organic growth for the fourth consecutive quarter) during Q2, which fell on the upper end of management's guidance range.
The Champion brand continued living up to its name, growing in all geographic regions and 18% overall. Even more impressive, outside of mass in the U.S., it grew over 70%. Pure-play brand stores contributed to this growth with great successes being reported across newly opened and previously existing stores in major cities across the U.S., Europe, and Asia with more planned, making it a truly global brand. While a downside for the brand came with the announcement that Target would not be renewing its contract for the C9 by Champion brands beginning in 2020, management reiterated that their investor day presentation forecasts assumed it would not be renewed and pointed out that the particular business had "matured" in its growth, making it a fairly minor disappointment. HBI maintains a strong relationship with TGT in its inner wear brands and has enormous additional growth drivers for the Champion brand to more than offset the loss of this business. Mr. Market sold off on the stock likely on this news, however, not only because of this lost revenue but because of what it could potentially reveal about the staying power (or lack thereof) of the Champion brand. While it appears to be wildly popular internationally, it may be slipping domestically, potentially undercutting management's rosy growth and margin expansion forecasts for the brand. I am not buying in to this fear, though, because the Champion brand continues to grow overall in the U.S. market and is being well received by younger generations at the pure-play stores mentioned by management in the conference call. Furthermore, management did not rule out the possibility of finding a new roll-out opportunity for the C9 brand, providing additional upside to their forecasts.
Adding to the Champion-led growth, global consumer-directed sales grew by 20% during the quarter as well. At 22% of total sales, this growth rate essentially accounts for their entire top line growth during the quarter (while Champion growth offset declines in areas like intimates). The company continues to invest in its own online presence as well as its sales relationship with Amazon (AMZN), both working together to drive continued double digit growth.
Given these numerous growth tailwinds and the company's marketing investments in stabilizing the U.S. intimate apparel business, HBI not only forecasts margin expansion and continued organic growth in the second half, but accelerating organic growth, claiming early strong results from its "back to school" marketing partnerships with retailers.
Valuation
HBI looks quite cheap compared to its historical yield and share price.
The main items dragging down the share price have been the heavy costs and debt associated with its acquisitions, which in turn have led to a cessation of dividend hikes and share buybacks. However, management forecasts reducing leverage to within its target range over the next several quarters, enabling them to resume buybacks and dividend growth. In the meantime, investors at today's prices can enjoy a dividend yield well north of 3% and solid mid to high single digit EPS growth through solid mid-single digit revenue growth and margin expansion from improving efficiencies and favorable product mix while interest expense will be declining due to deleveraging efforts. One buy-backs and dividend increases resume, shareholders should expect an additional 2-5% annual tailwind to total returns. Adding up the current yield, EPS growth, and future capital returns, and investors are looking at projected annualized returns of 10%+ over the near to medium term.
Investor Takeaway
It's crunch time for HBI: management needs to either put up with growing margins and accelerating organic growth in the second half, or shut up. They managed to instill significant investor confidence in their plan during their investor day presentation back in May as indicated by the share price increase. Now with TGT's declined C9 contract renewal and another lackluster quarter in the books, investors are once again getting jittery. This investment is clearly a bet on management's ability to deliver on promises in the second half. Not only do I have faith in management's ability to execute, but more importantly the current valuation provides a very favorable risk-reward profile. If management successfully delivers on their projections, this stock could be pushing the mid to high $20's by the end of the year (i.e., 40-50% upside). If it doesn't, it will likely remain mired in the mid-to-high teens barring total collapse of the business and/or other macroeconomic/market forces.
This article was written by
Samuel Smith is Vice President of Leonberg Capital, he has a diverse background that includes being lead analyst at several highly regarded dividend stock research firms. He is a Professional Engineer and Project Management Professional and holds a B.S. in Civil Engineering & Mathematics from the United States Military Academy at West Point and has a Masters in Engineering.
Samuel leads the investing group High Yield Investor investing group. Samuel teams up with Jussi Askola and Paul R. Drake where they focus on finding the right balance between safety, growth, yield, and value. High Yield Investor offers real-money core, retirement, and international portfolios. The services also features regular trade alert, educational content, and an active chat room of like minded investors. Learn more.Analyst’s Disclosure: I am/we are long HBI. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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