Whenever a stock zigs when we think we think it should zag, we – 1st) scratch our head, and 2nd) dig to see what the street knows that we don’t. But for the life of me, I don’t think todays rip is anything more than short covering in light of how bullish management was on cash flow. The building blocks are in place for this to be a $5 stock. If not for oscillations in the bid/ask like we have today, we would not be presented such astounding investment opportunities as to Short HBI into strength. Here’s what me and McLean think is driving the sentiment upside…
- Management’s cash flow confidence is undeniable. Yes, it took down the top end of cash flow guidance, but we’re still talking $775mm in CF for the year. That’s solid.
- It did not talk about next year. And Yes, we are at $390mm next year. Yes, that’d be an even 50% decline next year. That did not make its way into conversation.
- It did not talk about what was likely receivable factoring in 3Q,
- It did not talk about the positive impact of acquisitions on working capital,
- It did not address why core capex is running below depreciation,
- It did not talk about the danger of having abnormally low capex while asset utilization is at peak (pardon my aggressive stance here – but does ANYONE care about this?).
- And it certainly did not talk about how what we’d call a non-recurring $325mm positive swing in 2016 is so unlikely to be replicated next year, and why we can’t see working capital go the other way next year due to…
- Pressure in the wholesale channel due to store closures,
- New deal with AMZN (preferential terms) which also marginalizes traditional customers’ ability to use AMZN as a clearance channel for HBI’s product,
- Increased competition from Gildan at the low end, and premium brands at the high-end like Tommy J, Stance, Mack Weldon and anyone else that started using Facebook as marketing channel in 2016 – which in effect is the equivalent of opening up the biggest storefront in the world.
- Higher cotton costs – hurting inventory costs – not to mention wholesale pushback as the retailers refuse to pay higher raw material costs (which they don’t at cycle end when HBI is out-earning them by 2-3x).
- As for the direct cash flow guide, HBI broke it down as to where pieces will come from in 4Q:
- ~$250mm from Net Income and D&A
- $300-$350mm from working capital, mostly inventory
- Inventories cleaned up materially in Q3 relative to sales growth, and working capital sourced $140mm -- the best third quarter in 3 years. How can this lever not be wearing thin?
- In Q/A one question tried to get mgmt to say whether cash flow would be similar next year, and management would not touch that with a 20-foot pole.
- Referring to 2016 said "So, very confident, though, that we're going to get to the numbers that we've been talking about."
- But as noted, if there is going to be $350mm in CFFO in 4Q from working capital improvements, how can the company replicate that in the future.
We could see why people who’s year is hanging by a thread – and already capitalized on the 33% underperformance from the 2016 peak -- might want to bail on the short given CF confidence for a levered company. But 2017 will be such a different story, and HBI will have to back down in another 90 days when it guides to ’17. Rich Noll will be more removed from the story by then, and the truth can, and likely will, come out. We’ll work w KM on precise timing on a TRADE basis, but if you can look out 6 months, we’d press this one hard.
Our note from 10/27/16
HBI | The Case For A $5 Stock
Takeaway: How's HBI getting away with this? CEO leaves an eroding biz for successor. This guide down won't be the last -- by a long shot.
Our HBI Model. 73% Below Consensus.
Lowering Sales and Cash Flow targets four weeks after the CEO departs is just bad. My (McGough’s) personal opinion is that this caps off two years of incredibly bad behavior…
- underinvesting to boost margins,
- bad acquisitions at high prices,
- stripping out integration costs that upstanding companies would include as a cost of doing business, and
- getting paid on non-GAAP earnings,
- taking down the tax rate to 8%, and
- subsequently putting up sky high earnings/cash flow expectations when the environment otherwise prompted an otherwise savvy CEO to sell stock and subsequently leave his post at the age of 59.
We think that EPS power for this company will turn out to be $0.72 after the Pacific Brands deal goes South and proves to be a really bad idea -- i.e. in hindsight should be up to 20x EBITDA instead of the reported 12.5x (very high in itself) for such a marginal asset.
If you believe, as we do that we are at the end of an economic cycle, then we're looking at the following…
- 3-5% decline in organic revenue,
- a 500bp-1,00bp draw down in factory utilization,
- Gross Margins off by 300bp-500bp,
- Not much SG&A to cut -- anymore, at least -- 2% organic growth,
- EBITDA down by $400mm from $1bn in 2016 to $400mm in 2019,
- Higher debt levels and interest expense as HBI is stuck with deal-related debt and less cash flow to cover it,
- Tax rate headed back into the teens from 6% today,
- EPS of $0.72, or 73% below consensus.
On such materially lower numbers for an otherwise sub-quality, commodity-based company that is over-earning its wholesale channel by 2-3x, can't grow its own DTC, won't be able to pass through higher raw materials costs, and has financial leverage going the wrong way, we thinking an earnings multiple closer to 8-9x. That's equal to an EBITDA multiple of 6-8x -- which we'd still argue is too high. Mind you, vertically integrated underwear assets have traded in the private market at 4x at the trough of prior cycles (VFC w Vanity Fair -- comes to mind at 3.6x EBITDA). The name is trading at a 10% FCF yield if you believe in the Street's numbers -- but at an astonishingly lower 2%% if you believe in ours.
On our numbers we're looking at the following value per share on the following multiples…
8x EPS = $5-$6
6-8x EBITDA = $4-$6
10% FCF Yield = $5-$6
As it relates to this quarter in particular, here's what we liked (in fairness) and what we did not like.
The Positives
Making progress on working capital (at face value).
The company put up a solid 70% growth rate in cash from operations. Inventory corrected on the SIGMA with inventory growing in line with sales. This is mildly bullish for gross margin. This also puts HBI closer to its $775mm CFFO goal for the year.
However, we still need to see $567mm in 4Q to hit the target, which would be the best 4Q ever and up 80% over last year.
In addition, we can't rule out receivable factoring in 3Q -- which might put the company in the hole in 4Q, and would suggest that HBI manufactured cash in Noll's final quarter as CEO.
Restocking?
There was discussion of restocking at some major retailers starting mid-quarter, and where there's smoke there's fire. It seems that was the case for HBI basics. However given the organic guide at HBI, and comments from CRI this morning noting a pull forward of revenue in its wholesale channel alongside weak future orders, our thinking is that this restocking was a one quarter aberration.
The Negatives
E-comm/DTC was abysmal. Note that HBI does not operate its own underwear stores (is there such a thing?) and as such, virtually all DTC is e-comm. That business has been down in 7 straight quarters.
In 3Q, it was down by 11%, with EBIT down by 52%.
To be clear, if I was locked in a room and could only look at one P&L item in a quarter for any company in retail/non-durables, it would be DTC growth. It should be UP 50%, not down 11%.
HBI highlighted a partnership with AMZN, but the interesting thing is that wholesale accounts have been unloading excess product to AMZN all along. We'd like to see how the wholesalers like KSS, JCP, M, TGT and Dollar Stores will react to this development as they compete against one of their vendors that's putting up 2-3x the margins as the retail channel is.
The company did not address goals for 2017 -- leaving way too much hope out there across all its financials. We think we're going to see a very big guide down and/or an outright meaningful miss in 2017. We outline all the levers in our HBI deck (HBI Black Book Link: CLICK HERE).
- HBI was asked about where cash is kept globally since it is believed that the majority is locked up internationally as HBI enjoys such a low tax rate.
- Management chose not to say where it was and that they have it where they want it.
- Mgmt said -- specifically -- “We don't consider any of our cash to be trapped on a long-term basis” … “We haven't had a problem yet”.
- We think the IRS might have something to say about that, as they will be taking their hefty cut of anything brought into the US. Meanwhile the tax rate hit a new low of 6% on a TTM basis.
- Lastly, but certainly not least, was the downward organic growth revision.
- Organic growth was once again negative despite the basics performance management highlighted.
- And hidden in the FAQ document was the $100mm revision to 2016 acquisition impact on the top line. We had said that the impact was likely to me closer to $400mm this year, and it appears $440mm is the number.
- Since total revenue guidance was brought down, this implies that organic growth will be 1.6% in 4Q going against the -10% compare from last year, or a slowdown of 420bps on a 2 year basis.
- Management attributed to revision to better than expected performance for the acquisitions, yet didn’t choose to include that better than expected in the total revenue guide.
- #cagey
