As much as this is a great opportunity to lay into a company that we’ve loved to hate, we’re not going to go there (that much). The fact of the matter is that with the stock down 30.9% in a single session, we need to consider a) what its worth, b) if there’s more downside, and c) when it’s time to step in and (gasp) buy the stock.
The bottom line is that even with a 31% sell-off, it’s simply not cheap, and there are zero identifiable catalysts.
A few considerations.
- This is all part of the grand master story. GIL is (was) maxed out in its core t-shirt business, so it grew into fleece, then private label with US mass retailers, Asia, and capped it all off with an acquisition. Organic sales slowing, and increased capital on the balance sheet necessary to grow into lower margin businesses. Classic value destruction.
- Why don’t they just stick with what they’re good at? This company can manufacture a shirt like no other. It has new and efficient factories that workers actually want to show up for. This is a business that is all about capacity utilization. That’s why GIL, unlike fully outsourced companies like VFC, PVH, RL, NKE, LIZ, etc… faces such extreme fluctuations in Gross Margin. They’ve tried and tried to fill excess capacity. They’re probably not considering whether they have too much capacity, but they should be.
- They said that they’re sticking with their $0.20 per share accretion estimate for the Gold Toe acquisition. Ok…but is there really any way we can check that? Looking at old copies of our model, we were 2012 EBIT of $173mm and $1.33 in EPS. Then GIL spent $350mm for a $280mm business that generated about $45mm in EBIT. Six months later, we’re at $150mm in EBIT, and $1.25 in EPS. I guess we have to trust them that the new growth engine is perfectly intact.
- The core screenprint channel is still a mess. In 3Q we started to see a decline (-9%) in distributor shipments. GIL lowered 4Q shipment expectations to -5%. They ended up coming in -7.6% due to more aggressive destocking than they expected. Then the haircut for the upcoming quarter is expected to be -40%. Even if they sandbagged and it’s really down just 30%, this is roughly 60% of sales, and their track record in forecasting it is just flat-out poor. Our sense here is that GIL made the same mistake HBI did – they underestimated the extent to which core distribution channels pre-bought in advance of price increases.
- On the Gross Margin line, GIL is going to be realizing the impact of a 13% reduction in selling prices to distributors in basic T-shirts on higher priced cotton, a special distributor inventory devaluation that will impact EPS by $0.16, and extended downtime of manufacturing facilities on lower sales volume in what is already the lightest seasonal sales quarter. The result is implied gross margins of ~2% in order to back into GIL’s earnings outlook of -$0.40 assuming SG&A dollars remain flat (that is not a typo, 2% GMs).
Here are some changes to our model, including how we get to $1.25 next year.
- First off, our $1.25 gets us within spitting distance of the Street for the first time in 2-years. Their $1.30 guidance is in the realm of doable.
- On the top-line, we are looking at approximately ~$160-$180mm in incremental revs from Gold Toe less ~$40-$50mm in unprofitable sock revs as the company de-emphasizes its private label business. In addition, we have Activewear sales essentially flat for the year after a decline in 1H revenues by -30% and -16% in Q1 and Q2 respectively reflecting unit shipment declines and lower selling prices.
- In 2H, we are coming in below the company’s outlook which calls for industry shipments to be on par with last year’s levels after MSD declines in the 1H. We aren’t convinced that GIL will be able to maintain its 65% market share after an environment like the screenprint industry is going to see in the 1H where more aggressive smaller players are forced to move stock. As a result, not only is GIL’s share at risk, but so too is pricing. Having competitors on the ropes is a double edged sword.
- With higher cost cotton shifting into Q3 due to deferred inventory purchases in the channel and more competitive pricing, we don’t expect gross margin expansion until Q4.
- With a largely fixed cost structure, we expect SG&A to be up ~$30mm next year to support international growth and the integration of Gold Toe resulting in operating margins 500bps below F11 levels.
So, the question here is what GIL is worth, and what do you do with it? Let’s look at it a few different ways. It’s trading at…
- 13x $1.25 in earnings power. That’s fairish.
- 8.2x EBITDA. This is high, but it’s also skewed by Gildan’s tax-free status. In doing our best to normalize, it is at about 6.9x EBITDA. Translation = high.
- $4.8% FCF Yield. Nothing to write home about.
- Tangible book value of around $8.75. I’ll rarely use this metric, but this is an unbranded, commodity-based business. Aside from the raw asset value, you need to believe in some other value proposition to account for the remaining $7.50, and presumably much greater intrinsic value to take it meaningfully higher.
- It’s sheer domination in the screenprinting business. It’s terrible now, but it is cyclical and will bounce.
- With Gold Toe, it owns some goodwill associated with the Gold Toe brand, and UnderArmour sock license.
- The fact is that it remains the low-cost competitor. It’s having a tough time filling capacity now. But if the current management team can’t manage it appropriately, someone else can.
The bottom line for us is that there is absolutely not a single catalyst we can see to call the bottom in the stock. Even if the company has set lowball targets, we won’t find that out for another 3-months. That’s a long time in this tape. Also, on the call, this clearly did not seem like a management team that knows its numbers and strategically picked a safe target. Those people who will use valuation as a reason to buy GIL will not be happy with their decision over any near-term duration.
Notes from the call:
Forecasting a loss of $0.40 per share in the first quarter, second loss in the history of the company while public
2012 EPS: $1.30 as a result of the Q1 loss
Reduction is primarily due to:
- Higher cotton costs in 1H
- Lower selling prices for active wear
- Special distributor devaluation discount
- Non recurrence of income tax recoveries in 2011
4Q YoY decline of $0.42 vs $0.48 due mainly to
- significant increase in cotton costs which is not full recovered through price increases
- lower unit volume for active wear and
- the non reoccurrence of insurance proceeds and a cotton subsidy received in Q4 LY
Maintained market share in US distribution channel at 62.3%, essentially flat to last year
Lower unit sales for activewear was due to
- 6.3% reduction in shipments from US distributors to US screenprinters and investor destocking
- Negative factors were partially offset by
- impacts of income tax recoveries
- growth in international screen print shipments and
- more favorable product mix as well as earnings accretion from Gold Toe
"Compared to the assumptions in our August guidance, the unfavorable impact of weaker screen print demand and increase promotional discounting in the wholesale distributor channel at the end of the quarter and lower than forecast sock manufacturing efficiencies was more than offset by the later than anticipated timing of destocking of manufacturer inventories by wholesale distributors, which is not occurring in the first quarter of fiscal 2012, and the benefit of income tax recoveries. Weak demanded in increasing competitive pricing pressure in the screenprint markets have continued into the first quarter of fiscal 2012."
Shipments from US distributors to US screen prints: down 6.2% in October
- Distributors have been reluctant to replenish inventories under the assumption that gross selling prices will be reduced further
GIL Projecting a 40% decline in unit sales volume in the screen print markets in 1Q12 due to weakened demand and distributor destocking
Gildan has taken the following actions:
- In order for distributors to better plan and stimulate use end demand for Gildan products:
- Lowering gross selling prices in the US distributor channel and will apply the benefits of selling price reduction through existing distributor inventories
- The special distributor evaluation is expected to impact DTS in the first quarter by approximately $0.16 per share.
- In order to manage inventory levels:
- Extend normal X-mas shutdown of manufacturing facility
- Continuing to ramp Rio Nance V, largest and most cost efficient facility
- Also planning to reduce capacity of Rio Nance 1 and potentially modernize older technology
First Quarter Screen print business performance:
- "a perfect storm of negative factors"
- 1Q is lowest seasonal volume unit Q for the screenprint business
- Low seasonal demand is compounded by significant destocking
- Promotional activity is high while producers are using high cost cotton
- Selling price promotion will be abnormally high
- Special distributor inventory evaluation is projected to impact EPS by $0.16
- SG&A expense (largely fixed) and incurred evenly through the year will be abnormally high as percent of sales due to weak demand and destocking
- Results for screenprint are expected to improve gradually throughout the year
- Benefit from reduction in cotton costs in 2H
High cost cotton is not expected to continue into early in the third quarter due to weak demand and slow inventory turnover.
Assuming shipments from US distributors to US screenprinters will decline by 5% YoY in 2Q and unchanged in 2H
Also assuming average market share of approximately 65% in US distributor channel
"Every one million dozen change in screenprint sales volume impacts EPS by over $0.05 per share. In spite of the weak economic environment, we are projecting further penetration in international and other markets in fiscal 2012 due to lack of capacity constraints, which have limited our penetration in these markets and the introduction of new products."
4Q Sock performance +84% as a result of Gold Toe partially offset by lower inventory replenishments
- Sock business remained unprofitable despite gold toe due to high cost cotton
Projecting retail segment to report operating profit during FY12 through efficiency goals and declines in cotton prices
4Q selling price increases were implemented in Q4 and 1Q12 were aligned with cotton futures
- Thus prices do not pass through peak cotton costs and will therefore not reduce prices when cheaper cotton flows through the P&L
Gold Toe integration:
Will result in:
- Manufacturer savings
- Eliminate duplicate overhead expenses
- Result in further organic sales growth through Gildan's low cost vertical manufacturing making gold toe brands more competitive
- Pursuing new retail programs for Gold toe owned and licenses brands as well as Gildan brand development
FY11 EBITDA of $312.5 excluding Gold Toe
Expect FCF of $75-100mm in FY12
2012 capex expected to be $100mm
Manufacturing downtime extension
- Take roughly 12 days extra based on normal shutdown
- Rio Nance V started production in September
- Will be ramped up during 2012
- Cost difference should more than offset the extended shutdown or lower capacity of Rio Nance 1
- Rio Nance 1 will run through Q1 or Q2- will reduce capacity once Rio Nance V begins excelling (based on current outlook- subject to change with demand)
- Impact from the shutdown is about $0.15 (embedded in guidance) of which about half is in Q1, other half is throughout the year
- Rue Nancy 1 has been operating for 10 years, oldest facility, will take time to reenergize the infrastructure and potentially upgrade some of the technology in the facility during downtime
- Rue Nancy 5 costs of factory alone provide a payback compared to operating Rio Nance 1 and will be by far a cost reduction initiative in itself
Gold Toe Guidance
- $0.20 contribution from Gold Toe in 2012 provided earlier in the year still holds
Non-Profitable Program exit:
- Exiting non profitable programs that are large volume, basic and within the skill set that be be produced "within our own facilities"
- The Company's goal is to drive its own brand strategy:
- Exiting programs they do not fit the product and profitability criteria
- Leveraging Gold Toe as a marketing/merchandising company to drive not only Gold Toe brands, but Gildan brands as well
- Title sponsor of the New Mexico Bowl
- Signed a 3 yr deal with ESPN
- Just completed an event at Madison square Garden that gave exposure
- Ultimately the best way to build the brand and create shareholder value
- Not planning for a big recovery in the industry
- Believe the company will create demand and stimulate opportunity through aggressive price stance
- Pricing products now based on future cost and flushing through the inventory now at a higher Cost of Good sold
- This strategy will hopefully stimulate demand necessary to achieve Guidance
- Reductions primarily on basic shirts only right now
- Reduction represents a 13% discount (cost $3-$4/dz)
- A little bit more than half of the price increases they implemented during the year on Ts
- Not willing to give detail on pricing, but now expects higher cost cotton to push into Q3 COGS due to slower turns
Int’l Volume Expectations:
- Expect strong growth, no specifics
- Governor has been capacity which is now ramping
- Also adding new products
- Unit volume increases from int’l offsetting some of the U.S. distribution shortfall
- Plan on spending more this year to support Gildan brand
- Stepped up spending significantly last year, expect to continue to invest
- Looking to leverage SG&A in retail business (higher rates than overall)
Profitability Challenges at Retail:
- Haven’t raised prices in-line with higher cotton costs
- Integration issues with ramping U.S. production into the Honduras facility
- Retail product requires more changes to product creating manufacturing inefficiencies vs producing private label to customer specs
- Prior wholesale model of driving branch strategy changes with retail, are doing in most of activewear product, but need to establish in sock facilities as well
- Only implemented selling price increases at the end of the FY so have been impacted by higher cotton costs
- Retail business at ~$600mm should get margins roughly equal to wholesale margins
- Has been more difficult to raise prices at retail
- Turn inventory faster than most (3mo) so higher costs flowing through earlier
- Still realizing manufacturing inefficiencies that carry into 2012 in retail
- See margins improving gradually over the year
- Basically have brands for every channel – can maximize distribution
- Continue to divest programs that aren’t meeting profitability levels
- There is probably another $20-$40mm worth of business that they will have to either 1) increase pricing, 2) chg product categories, or 3) eliminate
- Danskin and Starter are profitable and still see big opportunity
- Distributors are looking at the future price coming down potentially so they are destocking shelves
- In Sept, end stock levels based on SKUs in stock were at 98%, now down to low 90s reflecting holes in customer inventories where they are waiting for GIL to cover costs of marking down inventory
- Channel on the whole in screenprint destocking while they see cotton come down buying only what they need – even in retail as well
- Believe pricing now is relative to where future pricing will be
Finanicial Health of Screenprinters:
- Not concerned, feel confident
Destocking in the Channel:
- Destocking pretty consistent across players
- No color on Broder specifically
- Broder is still largest customer
Unit Volume Expectations:
- Prices coming down in the market
- Were discounting product in November through incentives so distributors don’t want to take on the inventory risk
- Example: if 10mm dz in the channel and prices come down by $4 that’s $40mm of exposure re distributor’s inventory
- GIL is now addressing that by reducing prices
- Trying to take uncertainty out for both distributors and end users
- ‘hoping’ to see some activity and to stimulate new business by selling at a lower cost
Timing of Destocking:
- Really started in 1stand 2ndweek of October
- Believe most of destocking in rear-view because distributors at levels that they can’t fully service
“As far as the pricing is concerned, look, we don’t have a crystal ball, I can tell you that even the pricing based on
what we’ve set today is not representative of what the cost is of most of the manufacturers because everybody in
the industry has high cost cuts and there is no way to avoid it and so at the end of the day this question is how
much money our people willing to lose.”
- As the low cost producer, for GIL not to make a return in this environment is likely to mean that others are in even worse shape
- Could see further price reductions, still uncertain
- Have planned for some lower prices gradually during the year
- Have put some gradual price decreases into guidance, but anything more material would be further neg to EPS
- All of the $ is going towards completion of Rio Nance V
- The biomass project (cost savings initiative) is starting in January – fully ramped up by Q2
- Will see the benefits of these cost initiatives by Q4
- Benefits beyond $0.15 in EPS will more than offset $0.15 impact from closing facilities
- Also looking into investing in an electrical plant for sustainable power going forward
- Moving up in priority given increase in electricity costs in Central America
- Also looking to potentially expand Gold Toe ops in Charleston
- Taking time out in activewear near-term
- Have the capacity when demand returns
- For the first time in years they have the capacity to sell and are trying to aggressively looking for ways to fill it
- Sock business performance ex Gold Toe was a complete non-answer
- Not generating a good profit – probably where most if not all of the $30-$40mm in unprofitable business is
- Should start to see some Gold Toe efficiencies during the year
Retailers Potentially Looking for Further Price Reductions:
- Don’t expect it
- GIL didn’t bring pricing up as much as ‘a lot of the national brands did’
- Pretty stable
- Plan on launching several new programs under Gold Toe
- Trying to lever Gildan brand underwear as well
Starter at WMT:
- Didn’t lose any volume b/c sq. ft. is producing well, but lost 2 feet of space
- Starter wanted to put in real performance underwear and it didn’t perform well
- Selling equal with less space as they had sold with more space previously
- It’s the #1 selling product on the floor