Even with today’s blow up, people are currently paying for uninterrupted growth today at HBI. Not only is the growth suspect, but the cadence is as well. We should see the top line growth rate erode meaningfully throughout the next 6 quarters. The risk/reward here is NOT favorable.
Not a surprise with HBI’s reaction to its print today. Yes, it was an in-line quarter, but we’re starting to see cracks for which its valuation left little margin of error. We’ve been concerned about HBI for about two quarters now, and have had it near the top of our short list more recently (along with JC Penney, Carter’s, Gildan, and more recently, Under Armour).
Our conclusion on HBI is that it could be a very good story, if the management team realizes what it is and manages its playbook accordingly. They’ve been executing very well with their factory consolidation – to an extent that no one (except Gildan) has done so in the past. The problem, however, is that HBI is trying to be a growth company, instead of a ‘steady-but-slower-growth top-line with meaningful cash flow and de-levering balance sheet’ story. More specifically…
Long term top line growth is should be 2—4%. The category grows 1%. Then they take 1-3% share as they use proceeds of factory cost reductions to pass to retailers and consumers. But they’ve been printing top line of around 9% for the past 6 quarters. Much of that (5-6%) has been shelf space gains at Dollar Stores, WMT and TGT. But then, as they started to anniversary growth, what did they do? They started doing deals. One was big, the other small. But they both happened within a quarter of one another. Remember, the pitch upon the spin-off was lsd top line, hsd ebit, and mid-teens eps due to delevering the massive $2.6bn debt load that Sara Lee dropped on it. But instead of de-levering and paying underfunded pension liability, they’re doing deals? In addition, CFO Lee Wyatt just resigned. Our sense is that Wyatt and Knoll simply did not agree on strategy. Wyatt wanted to improve the balance sheet. Knoll wants to pursue an aggressive growth strategy – even if they have to buy growth.
People say it is cheap on earnings, which is absurd. There’s no reason why an asset-intensive vertically-integrated apparel company with $2bn in debt should be valued on anything other than EBITDA. It’s trading at about 8.2x EBITDA today. When vertically integrated apparel assets have traded hands in the past, they’ve gone for 3-5x EBITDA (ask the folks at VFC who had to give away their ops several yrs back at 4.6x EBITDA). If HBI trades below 4x EBITDA, there’s no equity value left.
People are currently paying for uninterrupted growth today at HBI. Not only is the growth suspect, but the cadence is as well. We should see the top line growth rate erode meaningfully throughout the next 6 quarters – unless HBI does more deals. That’s possible, but we suspect that the market will start to see through this.
The risk/reward here is NOT favorable.
Here are some of the more notable statements from management on the call.
- The volatility in this model is picking up.
They’re banking on MORE shelf space gains
- Moved from steady outlook to more volatility
- They’re looking for a price hike in Q4 to offset increase costs in the first half of 2012.
- Looking for negative price elasticity in back half
- Cutting back on unit inventory levels to manage inflation, and units are falling off less than prices going up
- But...HBI leads on price which allows temporary gaps in pricing against competitors
On channel inventory levels, Knoll noted that some channels are up, and some are down. But the ones that are having the most success are those that are being the most liberal with inventory build. (This synchs with our view that retailers overall need to accelerate inventory growth to command any kind of growth multiple).
- Space gains happen again after back to school and into holiday
- A lot of programs across a lot of retailers in all categories
- Looking for new offerings throughout a whole host of accounts (“lots of wins in lots of places”)
- Cotton went as low as a dollar – that was too low
- Need to be above a dollar and a quarter to maintain acreage against other crops
- Retailers don’t want low cotton as it will lead to negative comps in the back half of 2012