HBI snuck one past the goalie with the release of FAQ at 4:10pm Friday afternoon. Before we dive into the release, a few quick thoughts/reminders on the 4Q financial results.
- 4Q organic growth rate -5.5% on top of -10% in 4Q last year. That included higher finished goods inventory, and higher DSOs – which appears to be HBI pushing cancelled WMT orders to TGT.
- EPS missed by 5 cents, or 9%, while interest was slightly below guidance, tax rate was lower than guided, and non-GAAP charges were slightly above guidance. The real EPS performance was more like $0.49 vs the reported $0.53.
- CFFO missed the annual target 22% miss even with only 2 months of the year to go when guided, despite management being " very confident" in the numbers.
- Leverage back up to 4.2x, committed 60% of operating cash to dividends, mitigating ability to do deals or invest in the business to grow.
When roll-ups come to an end, it is a very ugly picture. There’s more ugliness to come. This cash flow draw down was the first domino.
Here’s McLean’s FAQ Breakdown
Q: Why was your Q4 Cash Flow from Operations below your guidance?
HBI’s A: Q4 Cash Flow from Operations was below our guidance due to lower sales (relative to our Q4 guidance).
Hedgeye’s Follow Up Questions…
- Why did sales miss by 7%? There were three weeks let in the quarter at the time of management’s last stint on the conference circuit. What is the visibility into the business with 80% of the quarter completed? Is this an issue with forecast accuracy, inadequate accounting processes/reporting systems, or what might otherwise be perceived as a ‘less than ethical’ move by management? I’m sure they’re very ethical executives. So let’s blame this one on bad systems.
- How much did re-stocking miss expectations? Also, it is noted (see below) that accounts receivable were high since "sales in Q4 came later in the quarter than expected". As far as we know, most mass retailers don’t stock up in mid to late December after a holiday season that missed sales expectations. Perhaps it’s more likely that terms were extended to put product inside Target that WMT otherwise cancelled. Per the K, HBI sales to Wal-Mart were down 9% in 2016, while sales to Target were up 5%. One of those two is currently playing offense, the other is playing defense -- guess which one accommodated HBI?
Q: Why did working capital miss?
HBI’s A: Working Capital/Other, our actual Q4 results were roughly $195 million, which was approximately $130 million lower than expected. The difference was essentially evenly split across four items: (1) A/R, as sales in Q4 came later in the quarter than expected; (2) Inventory, due to the sales miss, which was partially offset by additional inventory‐related actions (such as reduced purchases of raw materials, a longer time out period at our factories around the holidays); (3) A/P, as this was lower than expected due to some of the actions we took to offset inventory (i.e. lower raw material purchases); and, (4) Accruals, due to timing differences relative to our initial expectations.
Hedgeye’s Take…
The working capital miss really wasn’t across all 4 of these -- it’s all inventory, and then some.
- Let's look back, guidance was for inventory to be down $100-$150mm yy, which meant getting rid of about $300mm+ net in 4Q. We thought this was incredibly difficult, but of course, management was "very confident". And why in the world should anyone in the world doubt a stand-up management team that is ‘very confident.’?
- Inventory actually finished up $26mm, which means inventory missed by about $150mm or 115% of the total working capital miss, all while management took steps to REDUCE inventory during the quarter by not buying raw materials and cutting factory time. Sales only missed by $125mm, we see a disconnect.
- And yes, finished goods inventory % is at a 5-year high.
As it relates to the CFFO miss, HBI also noted
“On a normalized basis, which excludes the impact from future acquisitions and factors in the remaining acquisition synergies, the conclusion of acquisition and integration expenses and an assumption of minimal working capital use (driven by an assumption of flat to slight organic growth), our Cash Flow from Operations is estimated to be over $900 million annually…”
Here’s what we don’t get.
- You buy a couple ‘average at best' overearning assets at peaky multiples, adding roughly 15 points of reported growth. How does a ‘normal’ run rate for cash flow become nearly 2x the rate the company did in its best post-recession growth year?
- Perhaps $900mm is HBI’s "normalized" operating cash flow number for the Bulls – bc that’s the only thing that can (maybe) justify people looking past the balance sheet issues that are otherwise emerging when margins are peak, capex is at trough and the Enterprise has been revalued like a company with little operational or financial leverage.
- We put a normalized CFFO for HBI in the $400-$450mm range, and a fair value for the stock in the low teens. However, since capex is at trough, the company is over levered, and management is making bad capital decisions, our sense is that the focus will shift from CFFO to FCF – which supports a single digit stock.
Q: What is factored into your guidance for 2017?
HBI’s A: While there are many items that are factored into our guidance, a few of the key assumptions are: (1) We expect our online revenue, across all channels, to grow at a double‐digit rate…
Hedgeye’s Take: Innerwear was down 8% in 4Q, and down 2% for the year and that now includes online sales for wholesale partners. Our math shows that Amazon appears to be the only piece of online that is growing materially, but it's only about 1% of sales. So we need to see Amazon growing well into triple digits to make offset the B&M declines. And that is assuming that Amazon growth doesn’t further cannibalize B&M sales, which it likely will.
Q: [How do you get to guidance of 0-2% organic growth?]
HBI’s A: [It] includes the following assumptions: (1) Modest growth in our Activewear segment driven by the anniversary of U.S. sporting goods bankruptcies, continued momentum of Champion in the mass channel and growth in our Licensed Sports Apparel business.
Hedgeye's Take: Yes, we will anniversary the bankruptcies, but beware that more bankruptcies are being filed, and will continue to be filed. Our analysis suggests that we’ll see more in 2017 than the record number we saw last year (which in itself was greater than in 2009). In this retail landscape, they are secular and not one time. Also, a reminder that Kohl's is adding Under Armour to its brand offering as better brands go downstream to chase growth, we think that is very bearish for the Champion, Maidenform and Hanesbrands' share within Kohl's doors, which is about 5% of HBI revenue.
HBI Organic Growth Comment: Modest organic growth (constant currency) in our International segment driven by continued growth in Asia and growth from Hanes Australasia (Pacific Brands) and Champion Europe in the second half of 2017 as we anniversary these acquisitions
Hedgeye: Steiner’s Financials team has done some great work as to why Australia is in the midst of a housing bubble and impending financial collapse that is likely to be worse than what we experience in the US in The Great Recession. We doubt HBI was fully aware of the macro risk in the country when it paid nearly 13x EBITDA for the Pacific Brands assets. Just this week we saw data indicating a new high in Australian households reporting that income is ‘decreasing’, as well as a new low in ‘comfort with job security’.
Q: Can you provide any insights to your 2017 Cash Flow from Operations guidance?
HBI’s A: The mid‐point of our 2017 Cash Flow from Operations guidance is $675 million. Looking at the key components, it includes: (1) GAAP Net Income of approximately $650 million (mid‐point of our guidance)
We'll take the under. We’re at $440mm in CFFO – down 25% yy, with a 25% increase in CapEx. This is when ‘cheap’ becomes the mother of all value traps.
