No follow through on yesterday's 5.1% pop in oil prices. WTI back down today.
Takeaway: We added HBI to Investing Ideas on the short side on 3/31.
We added HBI to Investing Ideas as a short on 3/31/16. We don’t like the Brands, don’t like Management, and don’t like the Company, but that alone is no reason to short a Stock. What is, however, is the fact that we think earnings and margins are at peak. We’re 7% below consensus this year, -20% in ’17, -30% in ‘18, and -40% by year 3. Some argue that stock seems cheap today at a mid-teens multiple and 5% FCF Yield – though we really don’t follow that logic.
Once the dust clears from the acquisitions, special charges, and cotton prices normalize from the 7-year low, we think we’ll be looking at lower multiples on lower earnings and cash flow. A low double-digit multiple on our numbers gets us to a high-teen stock. Perhaps management agrees, especially CEO Noll who has cut his stake in half over four months.
HBI should release 1Q16 results around the 21st of April. This is not intended to be a call on the quarter, as it’s more of a margin and growth story that has run its course. For the most part, we expect earnings to be roughly in line with the Street this quarter. But unless HBI guides down, this might be the last beat/in-line quarter for a while.
After reporting weak revenue growth in 4Q15, HBI's stock price crashed 19% in 2 days. The stock has since rallied back 17% in line with the broader retail sector (XRT), yet the fundamental issues have not changed. Organic (core) growth slowed 800bps in 4Q, and organic compares are harder in 1Q and 3Q with 3Q being the toughest organic growth compare in over 2.5 years.
In addition, 1Q is the last quarter of top line help from the Knights Apparel acquisition in early April of 2015. The margin tailwind from cotton hitting 7 year lows is waning as much of the cheaper input costs have worked through the supply chain. Lastly, the sales to inventory spread sits at the worst level seen since 4Q11.
The risk over the trend duration is the announcement of new accretive acquisitions that will be followed by restructuring charges. That could cloak the slowdown in the underlying business, much like the Champion Europe acquisition announced this morning.
Here are some longer-looking factors to consider…
1) Why? Can someone, ANYONE, explain to us why HBI has operating margins of 15%? That’s demonstrably higher than the following companies – UA, RL, PVH, GES, CRI, ANF, KATE, and yes – even NKE. It’s also well above its key retailers (WMT, TGT, KSS, JCP, AMZN).
Why should a company whose primary brand sells through mass channels and department stores have higher margins than the best brands in the business? As hard as we try, we cannot figure it out aside from over-earning due to a 7-year trough in cotton prices and the temporary benefit of being a serial acquirer and restructurer of companies in an effort to grow away from its core.
2) Let’s consider how the margin structure changed at HBI over the past 4-years. Cotton peaked in the market at about $2.00 in 2011, which ultimately flowed through and hit HBI’s margins in 2012. That was when the stock was at a split-adjusted $5. Overly penalized, for sure.
But we’d argue we are seeing the inverse today. Since the precipitous decline in cotton to the $0.57 level, HBI recouped seven (7) full points in Gross Margin. Over the same time period, how much did the company see flow through to EBIT margin? Seven. Ordinarily, we’d like to see a company invest more of the upside.
They’ll say they ‘innovate to elevate’. But we’ll bet there’s a direct flow through in margin downside if either a) cotton prices head higher, or b) if Wal-Mart and Target decide that HBI is making too much money.
3) Buying at the Top? HBI is buying back so much stock while margins are at all-time peaks (and management is selling) comes across as flat-out reckless. In fairness to HBI management, we see this behavior from most major consumer companies – they buy stock when they CAN and not when they SHOULD. This is not unlike Target, which is taking the incremental $1.2bn it gained from its pharmacy business and using it to buy back shares at $80. Our sense is that it will come back to haunt them if we’re right on earnings and this stock is in the high teens.
4) Acquisition Behavior Bothers Us. This company has acquired an average of a company a year for 5-years for a total of $1.5bn. It’s also taken $546mm in restructuring charges, or 25% of non-GAAP EBIT, since 2013 when HBI started its recent streak of acquisitions with Maidenform in October 2013.
5) As hard as the company might try, HBI cannot simply grow online. If there was only one statistic we could see for a consumer brand to gauge the health of its business, it would be the direct to consumer (DTC) sales of its product. DTC sales at HBI, however, have shrunk as a percent of sales over the past 5 years from 9.5% to 6.8%. We’ve never seen a company do that before.
Our sense is that WMT, TGT, the Department Stores, and Dollar Stores all would react severely if HBI tried to go direct. And yes, we understand that WMT and AMZN sell Hanesbrands online, which counts as a wholesale sale on the P&L but shows up online. It does not matter. Margins are better for a direct sale full-stop.
We refuse to accept the premise that underwear is not a category that lends itself to online sales. Tell that to Tommy John, Lululemon, and Under Armour, who all have 30-40%+ online businesses and are charging $30-$40 per pair (not package), and they can hardly keep them in stock.
It’s abundantly clear where the trend is going – and HBI can innovate all it wants, but it’s likely not going to be a player in this premium game.
6) When management buys a share of stock, we’ll step back and question our logic (though we’ve done that a few times already). We have seen an absolutely massive degree of selling from the management team over the past year – see CEO Rich Noll’s selling activity below. Specifically, he has sold $85mm in stock over the past 14 months, most of that +/- $2 of where it is trading today. Last time Noll's ownership % was this low (0.2%) was in January 2010.
Earlier today the Hedgeye Macro Team, led by CEO Keith McCullough, hosted its quarterly Macro Themes conference call in which it detailed the THREE MOST IMPORTANT MACRO TRENDS it has identified for 2Q16 and the associated investment implications.
CLICK HERE to watch a replay of today's presentation.
For the audio replay CLICK HERE
For the video replay CLICK HERE
To access the presentation materials CLICK HERE
Q2 2016 MACRO THEMES OVERVIEW:
#TheCycle: With the recessionary industrial data ongoing, employment, income and consumption growth decelerating, corporate profits facing a 3rd quarter of negative growth and Commercial and Industrial credit tightening, the domestic economic, profit and credit cycles are all past peak and continue to traverse their downslope. We’ll update our cycle view and detail why growth slowing – and its associated allocations – remains the call as the U.S. economy faces its toughest GDP comp of the cycle in 2Q16.
#BeliefSystem: The notion that central bankers are increasingly pushing on a string is being progressively priced into global financial markets – with one lone holdout: U.S. equities. While we admire the blind faith of domestic stock market operators in Yellen’s ability to keep “the game” going, we are keen to cite specific risks that marginally dovish policy in the U.S. will fail to overcome the depths of the domestic economic, credit and corporate profit cycles.
#DemographyDebates: We’re entering an election season that could hugely impact markets – and probably not in a good way! What’s the impact of a Clinton or Trump victory and how will market practitioners react? We’ll also discuss housing and the impact of millennials and immigrants in shifting demand. Finally, we’ll exam a recurring theme of U.S. growth slowing – what’s under the hood for earnings and inflation expectations in 2016?
-The Hedgeye Macro Team
There's been a massive rally in Long Bonds today as the Fed tacitly confirmed our #GrowthSlowing macro theme yesterday. On a related note, we are still advising our subscribers toown TLT.
There have been fairly stark drawdowns across global equity markets year-to-date. Another symptom of slowing growth. Here's an abbreviated YTD scorecard:
Takeaway: Increasing signs of risk and fragility are revealing themselves around the globe.
In case you missed it, just last night, IMF head Christine Lagarde said that growth has been "too low for too long," many people were "simply not feeling it" and warned that the IMF may lower its global growth forecast.
In related news.
Unfortunately... Lagarde returned to the old chestnut that central planners had the tools to gin up economic sentiment, activity, etc. As we've noted, monetary policy potency is failing around the world. Here's analysis from Hedgeye CEO Keith McCullough in a note sent to subscribers this morning:
"But what do doves do when the #BeliefSystem on central-market-planning is breaking down? Draghi + Constancio both out this morning trying “whatever is needed” … Draghi says he “will not surrender”… Euro only moving -0.1% on that; Spanish and Italian stocks barely up and remain in crash mode."
The dim outlook in Europe isn't getting any brighter.
Here's what negative interest rates (NIRP) really do to an economy via the Bank of International Settlements. According the Reuters:
"Euro zone banks should be encouraged to keep more of their profits rather than pay dividends, to bolster their capital and finance new loans, the head of research of the Bank of International Settlements [Hyun Song Shin] said on Thursday...
In his speech, Shin also said negative central bank interest rates discourage lending by squeezing the margin between the rate at which banks lend, which falls along with the policy rate, and the rate on deposits, which rarely goes below zero."
Not to mention Japan's crashing equity markets:
The #BeliefSystem that central planners can bend and smooth economic gravity is breaking down.
Takeaway: All five active equity categories continued to lose funds last week; total eq MF flow came to -$4.9 B. Meanwhile passive equity took +$2.0 B
Investment Company Institute Mutual Fund Data and ETF Money Flow:
The landscape between passive ETFs and mutual funds in fixed income is starting to look a lot like the landscape in equities. An inflection point is now evident in the growth rate of passive bond products versus funds starting in 3Q15 with fixed income ETFs growing through the volatility in credit and now cumulatively ahead of running net new assets in funds. The entire equity complex has shifted toward passive products for some time now making the chart below a future look at how the pie will shift in fixed income.
Specifically during the week, the latest ICI survey again relayed this migration for the five-days ending March 30th; all five equity mutual fund categories experienced withdrawals, bringing the total equity mutual fund flow to -$4.9 billion. Meanwhile, passive equity ETFs took in +$2.0 billion.
In fixed income, taxable bond funds experienced a -$195 million outflow as investors continue to prefer tax-free municipal bonds, which took in +$1.4 billion last week.
In the most recent 5-day period ending March 30th, total equity mutual funds put up net outflows of -$4.9 billion, trailing the year-to-date weekly average outflow of -$798 million and the 2015 average outflow of -$1.6 billion.
Fixed income mutual funds put up net inflows of +$1.2 billion, outpacing the year-to-date weekly average inflow of +$1.1 billion and the 2015 average outflow of -$475 million.
Equity ETFs had net subscriptions of +$2.0 billion, outpacing the year-to-date weekly average outflow of -$1.6 billion but trailing the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$258 million, trailing the year-to-date weekly average inflow of +$2.1 billion and the 2015 average inflow of +$1.0 billion.
Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.
Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2015 and the weekly year-to-date average for 2016:
Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.
Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2015, and the weekly year-to-date average for 2016. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:
Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, the long treasury TLT ETF experienced a -$415 million or -4% outflow, although it has experienced the largest inflow YTD on a percentage basis of +48%.
Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.
The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$4.4 billion spread for the week (-$2.9 billion of total equity outflow net of the +$1.5 billion inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is -$422 million (negative numbers imply more positive money flow to bonds for the week) with a 52-week high of +$20.2 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)
Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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