Usually a company’s print will leave us squarely supporting either a bullish or bearish case. But in the case of HBI’s 4Q12, we come out right in between.
On the plus side, HBI is the poster child why you should never count against a company that is paying down its debt to drive EPS. We did not appropriately respect this factor, and it was a mistake. Over the past year HBI pas paid off nearly 40% of its debt, taking interest expense down by $40mm during a time when EBIT was off by $20mm (due to product costs). During that time period, HBI’s stock went from $22 to $38. Yes, the market was partially banking on a materials/pricing-driven margin recovery, but we’re hard pressed to find anyone who owned the stock who did not have debt reduction as part of their core thesis.
Management highlighted this many times on the call – arguably more than necessary. But when we step back and analyze the situation, we could see why. Back in 2006 when Sara Lee spun out Hanesbrands, it did so with a $2.5bn debtload and minimal cash. Rich Knoll wasn’t too happy about it back then, and has had the team focused on reducing debt (balanced with sporadic bolt-on acquisitions) over the past six years. He’s finally got the end in sight. We give the team credit.
After the debt reduction, we really couldn’t find a lot to get excited about. Consider the following.
1) Operating margins in the last two quarters came in at 13%, and guidance for next year has margins at new peaks. This level pegs HBI in line with brands like Under Armour, and within a point of Nike. We know that the businesses are different, but as a simple litmus test we wonder if HBI can consistently operate at a level above those brands.
2) The company noted that a 3-4% digit top line growth rate can be leveraged into double digit EPS growth ‘for a very very long time’. This is consistent with past statements. But with margins at new peaks and the de-leverage story nearly complete, it has to come in large part from top line growth. That’s harder to bank on than deleverage for a company in this business.
3) We give the company credit for investing an extra 3-4% in SG&A in 2013 in advertising – which is something we’ll almost always applaud. But aside from that, there wasn’t much mentioned in the way of major initiatives to drive the top line. We heard a lot about driving efficiency, but ultimately the top line is what will get us excited given that HBI is operating above peak margin levels.
4) Management discussed acquisitions in the context of growth – which is fine. After all, it’s worked for them in the past. Put we’re incrementally concerned that we might need to rely more on deal activity.
In the end, we think that the company is being managed well, and that that the risk of being blown up in this position near-term is not significant at 11x a doable FY13 number. But on the flip side, we simply struggled to find anything that makes us excited to buy this name after such incredible (and well deserved) performance.
We don’t think we’re alone in the group of people that wants to see -- in much greater detail -- how HBI is going to drive its financial model on a go forward basis when it hosts its investor day later this month.