This quarter should be abysmal, with a 3,000bp sequential slowdown in sales, and a 1,000bp erosion in margins. Yes, you read that right, I did not err with too many zeros. It would take a lot for me to ever turn fundamentally positive on the trajectory of this company’s margins long-term, as it is growing into slower growth businesses where it is a price taker with increased capital requirements to sustain growth and profitability. That’s not a disaster scenario as long as management realizes it. This team does not.
But few things are linear in this business. After missing and/or guiding down for the past six quarters, 1Q09 should mark the bottom for GIL. Note that the CEO sold 3.6mm shares of stock about this time last year – just before the business completely fell apart and over $4bn in equity value went away. Well…at least he avoided losing $130mm in his own capital.
Here are a few considerations on the quarter.
a. Negatives: 1) Pricing down 7-9% at a minimum, and GIL does not benefit from price increases granted by WMT to the extent as Hanesbrands and Fruit due to meaningfully less exposure. 2) FX has been a 1.5% tailwind over the past year. At current FX cross rates, this reverts to a -1.5% headwind. 3) Prewett acquisition has helped revs for the past 11 months. GIL shows 1 quarter of that in this quarter, which helps by 4% in total, but then we’re back to relying on organic growth – where GIL has struggled.
b. Positives: 1) 1Q is the least significant revenue quarter. 2) There’s a 5-10% volume opportunity this year from Europe, with a call option on Japan and Mexico. 3) The US mass retail underwear program started in 3Q, which still leaves some yy growth for 2 more quarters.
2) Margins: a) GIL comps in 1Q against a 600bp margin boost due to mix last year. b) Inventories were +32% at the end of 4Q relative to 27% growth in sales. That’s not great, but does not make me too queasy. c) The biggest negative is also emerging into a positive. Cotton will be a crushing blow to GIL this quarter. Every penny in cotton prices equals about $0.035 in EPS. With cotton having been cut by $0.30 to about $0.50 over the past nine months, we’re approaching the inflection point where the 9-12-month gap from purchase to booking as COGS on the P&L shows up in earnings.
3) Capex/Working Cap: Capital expenditures should be up by about $15mm off a base of ~$100mm in ’09 to expand the DR facility and Rio Nance One. This should add an incremental 7-8mm dozens of annual capacity (8%). Keep in mind that there should also be $70mm of additional working capital to support growth in 2010 and the cash payment resulting from the CRA audit (~$17mm).