Following a 30% tailspin just 2mo ago, the stock is back to pre-‘announcement’ levels. Despite the modest improvement, we think the risk/reward is still unfavorable given the current level of uncertainty and execution risk.
Gildan reported a modest beat after severely haircutting expectations some 35% last quarter. Just two months later, following a 30% tailspin, the stock is back to pre-‘announcement’ levels. It’s acting like the incremental pros in the quarter far outweigh the cons, we disagree. GIL is shifting its focus toward growing its own retail via Gold Toe and its international business. We expect this to cause transitional interruptions in the process, which the stock is does not currently reflect.
Let’s take a look at the key highlights at each end of the spectrum this quarter:
- While pricing remains challenging in the U.S. wholesale distributor channel, GIL has been able to get some pricing in the retail channel, which added $10mm in revs (+3%) and accounted for some of the unanticipated upside in sales this quarter.
- International is finally starting to materialize contributing what we estimate to be less than $10mm of revs in the quarter. It has been identified as an opportunity for a few years now, but the company has never had the capacity to handle the extra business. Ironically, just as international demand comes on, the company is taking one of its facilities and capacity off with the closure of Rio Nance 1 at the end of Q2. The opportunity there is to potentially upgrade the facility to improve efficiency, but for now it’s going to be mothballed for the near-term.
- With market share in its core t-shirt and fleece markets up around 65% it’s a challenge to maintain share, but GIL was up roughly 4pts yy though down ~1pt sequentially. Perhaps one of the more bullish results of the quarter was GIL’s unit growth coming in up +3-5% vs. the industry down 3-4%. We think this can be primarily attributed to the company being one of the first to take pricing down amidst an aggressive destocking environment at year-end.
- Pricing in the U.S. wholesale distributor business remains highly unstable. While December was a bit less promotional than expected, destocking continues leading to further heightened promotional activity. In fact, the company noted it expects promotional activity to increase through Q2 before improving sometime in Q3. That suggests we’re only half way through this irrationally competitive environment at best.
- Another variable to consider is that GIL is not fully hedged nor bought for F12. The company’s guidance assumes the remainder of Q4 purchases will be made a current spot prices. This could go both ways.
- GIL is growing its own retail and international business the same time CapEx is at multi-year lows and SG&A has to head higher if the company expects to capitalize on these opportunities. That could definitely be positive for the business 2-3 years out, but will require significant investment near-term – something GIL is not accustomed to with a historical SG&A ratio of 10-11%.
There are two additinal points to consider. First, management suggested that the Branded Apparel business (~25% of sales) could eventually achieve profitability similar to Printwear in the mid-20s. Its currently just about break even. If we want to paint a super bullish scenario and assume GIL is running at 25% margins (closer to 20% with corporate allocations) we are looking at $3+/sh in earnings power. We think the mere suggestion of this level of profitability was viewed positively if not flat out bullish, but there are a lot of questions between now and then that don’t appear to be appropriately discounted in the stock.
It’s also worth noting that the company hasn’t operated with this type of leverage since ’02-’03 when GIL shifted to its off-shoring model – they don’t have that lever anymore. Given that management didn’t repurchase any stock during the quarter, our sense is they aren’t comfortable running this thin. With the entire 1H generating negative FCF its will provide the company little financial flexibility while simultaneously looking to expand new growth businesses.
We fully acknowledge that there was an improvement in fundamentals on the margin, but not significantly enough to completely dismiss the impact of perhaps the most challenging six-month period in company history. We’re shaking out at $1.08 this year and $1.90 next year reflecting an 22x and 12.5x earnings multiple, and 14.5x and 10x EBITDA = not cheap.
These estimates are predicated on 13.5% revenue growth this year and 12% for next year reflecting the incremental revenue from Gold Toe, pricing in Branded Apparel, and growth of retail and international offsetting the impact of lower unit sales and pricing from destocking in the 1H. In addition, we are assuming gross margins of 16% in Q2 reflecting a sequential increase from Q1 due to the absence of an inventory devaluation (= 7pts), the impact of manufacturing downtime (=3-4pts), and higher unit volume. Similarly, with the closure of Rio Nance 1 at the end of Q2 and higher utilization, we have margins up to 24-25% in the 2H and up 450bps next year to 23.5% reflecting 300-400bps from lapping the interruptions of the 1H F12, higher utilization, and improved manufacturing efficiencies. While we expect SG&A growth (+20%) to outpace sales (+12%) in support of retail and international initiatives, we expect operating margins to expand 366bps in F13.
Despite the modest improvement, we think the risk/reward is still unfavorable given the current level of uncertainty and execution risk.
Here are our notes from the call:
Branded Apparel: +93%
GM: 2.1%; -2265bps
- Selling prices slightly higher than projected in December - due to lower projected promotional discounting in Dec
- Q1 loss due to:
- Still consuming inventories made at peak cost
- Avg cost of cotton in Q1 was more than double yy = $0.45/sh impact
- Selling prices in print were reduced during Q1 in-line with current futures initial through ST promotions and then formal reduction in gross selling prices announced in De
- Selling prices in Branded Apparel have remained largely unchanged and were increased at the end of FY to reflect current cotton future costs
- U.S. wholesale distributors delayed replenishment of inventory in anticipation of the above selling price reductions in printwear
- Distributors were able to lower inventories in Q1 b/c seasonally lowest
- De-stocking of distributor inventories resulted in close to 40% reduction in GIL's unit sales in Q1 and significantly more impactful than the 3.9% decline in screenprinter demand last yr
- Partially offset by higher market sales and higher shipments to Europe and other Int'l mkts
- Lower Printwear sales impacted EPS by $0.25
- Benefit of Printwear selling price reduction applied to distributor inventories devaluatation = $0.16
- Extended manufacturing shutdown taken in December to manage inventory levels = $0.07
- These factors resulted in segment operating losswhen otherwise profitable
- Improved results due to higher selling prices implemented in Q4
- Improved sock manufacturing efficiencies
- Accretion from GoldToe
- Expect results to continue to improve as lower cost cotton cycles through after Q2 + manufacturing efficiencies as sock facility ramps with integration of GT
- SG&A expenses for branded apparel division saddled with infrastructure put in place to support LT plan
- As well as duplication of costs to the GT acq
- Expect expenses for BA to be more inline with sales despite higher development costs associated with GT for retail over time
- Inventories up 67% (down 6pts seq)
- EPS $0.20
- Revs +$500mm
- Contribution from GoldToe
- Higher cotton costs expected to impact EPS by $0.70 vs. last yr
- Impact of higher cotton costs projected to be largely offset by higher printwear unit sales despite assumed industry demand in U.S. distributor channel down -5%
- And market share gains and increased int'l penetration, higher selling prices, efficiencies and accretion from GT
- Higher cost cotton to roll of in Q3
- Assumes GIL covers remaining open cotton purchases for Q4 at current rates
- No recovery in overall industry shipments to U.S. distributor channel - guidance assuming 5% decline in Q2 and flat in 2H compared to low base in F11 when demand was down 8%
- Mkt share in U.S. distributor channel of ~65%
- Industry pricing slightly lower than Q1; printwear is currently aligned with mkt
- The industry has experienced inflation in labor, energy and other input costs - no assurance of rational pricing and further promotional activity will not occur
- Price increases implemented at retail in Q4 stick
- Progressing with facility for activewear and underwear expect to be online by end of year
Will be lowest cost facility adding capacity and further manufacturing efficiencies in F13
- Expect further efficiencies in sock manufacturing as it ramps up
- Temporarily retired RN1 to manage pace of capacity expansion at end of Q2
- CapEx still ~$100mm for F12
- FCF of $75-$100mm; burn cash in Q2, generate in 2H
- Did not buy any stock despite stock price decline
Branded Apparel Margins:
- Anticipate similar to wholesale in the long run ~25%
- Will take time given investments over the next few years
- Avg. quarterly cost peaked at ~$1.60 in Q4 and still flowing through until Q3
- Have hedges into Q4
Promotions / Price Reductions:
- t-shirts and fleece
- Current environment in-line with projections
- Q2 assumes some additional promotions from Q1
- Pricing is slightly lower this quarter than Q1 as expected
- Expect strong sales growth in Printwear due to int'l penetration and some inventory destocking by U.S. distributors and increased market share
Wholesale Distributor Inventory Levels:
- ~45% relative to GIL's share in low 60s
- So far in January seeing stronger POS than projected; also in Feb
- 30% increase in int'l
- Hadn't had inventory historically to support
- Reflects opportunity in Mexico and Europe
- All int'l markets doing exceptionally well
- Have placed over 15,000 stores and locations
- Testing GT underwear in different retailers
- Expanding some categories
- Launched GT product called solutions - compression sock
- Have secured new programs for the fall
- Pushing for BTS and holiday promotional items
- Re Q2 guidance assuming GT contribution is similar ~$50-$60mm, restocking is some (small) but mostly international penetration within screen print channel
- Other competitors have had to take write-downs because goods sold for under cost
- There is still some irrational pricing taking place
- So far GIL is running well ahead of -5% decline in shipments
- "So in certain cases, I would say that there is definitely irrational pricing going on in the marketplace at even today's levels. So if the price does continue to deteriorate, it's because it's irrational, it’s not something that I think is sustainable first of all. As well as the same competitors that are pushing pricing down potentially in this channel are racing as fast as they can to raise prices at retail because they are running through all the high cost cotton. So I think as an industry, everybody is in the same boat. We are going to be, obviously, consuming our high cost cotton by the end of -- from the beginning of our third quarter. We feel comfortable with our positioning. We also feel comfortable we can command a premium for our products."
GIL Inventory Levels:
- Inventories up 67% = 100mm from higher costs (27%); 60mm GT (16%); balance is units (23%)
- POS is down overall at retail b/c raising prices
- Elasticity almost direct 1/1 relation
- Took two small price increases at retail vs industry increases in 30%-40% range
- Prices increases added ~$10mm in revs to the quarter = +3%
- Inventories down much more than POS unit reduction
- Taking out a little more time during Easter
- Will have 70-75mm dzn of Activewear capacity with remaining 3 facilities
Mid-Tier & JCP:
- Think JCP strategy is going to work well for GIL
- Got tripped up in answering saying they were mentioned as one of the opportunities…overall happy with Gold Toe placement