Expectations need to come down meaningfully. Unlikely to do it on this call. That would be an absolute ‘multiple-crusher’ and the co knows it. Likely to temper 2Q and promise 2H hockey stick. There’s no way out here over TREND or TAIL duration. I said it at $29, I’ll say it today at $21.81, and I’ll likely say it at $10 (and STILL stay short) – this will be the best short of my career – until I find a new Best Short of my Career.
What we know…
Qtr already preannounced…puzzling circumstances (CFO retiring in 9mos w in-line guide), but positive reaction nonetheless.
- 1Q revenue guided at $1.38bn, slightly below both the street and our model.
- Adjusted (ie made-up) EPS guided to the top of the prior range, growing about 8% yy, in-line with our expectation.
- GAAP (ie REAL) EPS was guided 10% below the street, meaning EPS missed but the company is taking charges higher than plan from acquisitions done 3 years ago.
- The big positive data point is that CFFO is guided to be -$25mm to -$50mm, or about $200mm better than last year and well ahead of street expectations. This looks to be bullish, however we will wait to see what the cash flow composition looks like before we consider it to be a positive. Since GAAP EPS missed, it's clear the good cash number was not from sales and margin outperformance. There’s covenant risk, and HBI needs to manufacture all the cash it can, until it can’t.
Here are the TRADE/TREND factors where we’re focused:
Acquisition vs Organic: Opacity should increase.
- HBI guidance is for $410mm acquisition benefit in 1H and $420-$430mm for the full year. We'll be looking for any change on the margin there.
- HBI has either misjudged or mis-guided the acquisition benefit more often than not since 2013. The easy call for a management team we don’t trust is that it simply played guidance. But the reality is that I don’t think the company actually knows with the specificity that the Street needs/deserves.
Inventory: We’re hyper-focused on the composition of working capital given the positive cash flow guide.
- We'll particularly be interested in the inventory trend, both the total inventories, and specifically the finished goods portion (filed in the Q).
- Inventory cleaned up in 4Q, but management commented that it was due to ‘actions’ (whatever those are) to reduce raw materials purchasing and cutting factory hours to suppress work in process.
- We think that’s long term margin bearish since cotton prices have gone nowhere but up, and the risk to maintaining peak utilization.
2Q Guide/2H Hockey Stick: Since the company held full year guidance on the preannouncement a few weeks ago, any change to full year on this print would be a ‘multiple crusher’. Even a sub-par management team knows this. That said, 2H rev expectations are at risk.
- Our sense is tempering 2Q revs and guiding to a 2H hockey stick while it pushes product through the pipe with weaker terms or margins (or both) to aggressively hit its unrealistic growth forecast.
- The company will leverage year 1 of acquisitions until 3Q, at which point whatever purchase accounting levers were pulled to boost cash flow will have to be lapped.
- 2H is guided to have an acceleration in organic sales, when all the retail data points we see signal organic revenue should continue to slow. Share loss appears to be accelerating, with price concession being one of the only ways to halt it. Keep in mind that HBI is over-earning its (shrinking) distro channel by an unsustainable 3x.
- HBI needs to have its leverage ratio at 4.0x or below for 4Q to prevent breaching a covenant on its term loan. It’s pushed out either R&D and/or marketing in each of the past 2-years. Now either it pays the piper, or the product gets even less relevant.
- 2H is where rising cotton prices should start flowing through to the P&L.
- CFO Richard Moss is planning to retire at the end of 2017. Perhaps that means walking away before HBI has to print 4Q17 and guide 2018. But we’re probably reading into that too much and giving them too much credit for gaming the Street.
The HedgeyeRetail HBI Short Call
Stage 1. 2006 – 2010
- Average brands in average spin from average parent laden with above average debt (4.4x leverage).
- Traded at 6-7x EBITDA
Stage 2. 2010-2013
- Repair balance sheet.
- Pay down $760mm in debt
- Delever to 1.9x
- Cap off with a dividend.
- Stock revalued at 11-13x EBITDA
Stage 3. 2014-2016.
- Share loss accelerates to Gildan on low end, and Premium brands on the high end (note: the middle stinks).
- HBI immediately starts doing acquisitions – average brands at/near peak earnings at/near peak multiples – bc management is financially incentivized to do so.
- Factory utilization goes to peak. Capex as a percent of sales goes to trough. This is the opposite of what any vertically owned manufacturer/brand in any category should do.
- Margins go from 8% to 15%. Overearning its (disintegrating) wholesale channel by a factor of 3x – the highest in history be a wide margin.
- Stock is revalued at 13-15x EBITDA – the same as the no-name assets it is buying at peak earnings.
- CEO quits
Stage 4. 2017-2018
- CFO quits
- Underinvested in PP&E to drive top line, so sales continue to erode
- Levered back up to 4.2x. Busts a covenant at 4.5x
- No longer has the balance sheet to a) do deals, and b) invest in PP&E to grow organically around a shrinking wholesale pipe
- Four months ago it upped dividend by 30% on a $760mm CFFO number. Then missed CFFO by $150mm
- On our CFFO number – which is another $200mm miss, HBI is guaranteeing 60% of its ‘trough capex FCF’ in the form of a dividend after buying back $700mm in stock 30-40% higher.
- Finished goods inventory sitting at historical highs.
- Promised an unrealistic 0-2% organic growth rate when it can’t reverse its (9%) run-rate with biggest customer.
- Amazon not an option – but rather a threat.
- Sales decline by 3-5%
- Gross Margins erode by 200bps, and EBIT by 300-350bps as it deleverages fixed infrastructure.
- CFFO declines another $200mm
- People stop valuing this thing on ‘adjusted EPS and CFFO’ and start valuing it on FCF given leverage and capital structure.
- If it trades back at the multiple of a levered vertically-integrated apparel brand (6x EBITDA) we get a $5-6 stock.
- If it trades at the 3-4x Warren Buffet and VFC have transacted in these businesses in the past (and the price that Sara Lee was willing to bail on) then there’s zero equity value left.
- Is this a Ch11? No. But that does not mean it needs to trade in the equity market.
This company does not need equity value. It is a poster child for a loser in #Retail5.0
