Takeaway: As bizarre and shady as this deal/press release is, it’s 100% in line with what HBI does. The opacity around numbers works, until it doesn’t

I don’t get this HBI release today. In-line pre-announce. Did another deal. Tiny…bc its balance sheet only allows it to do something tiny, before a breach. Said ‘returned to organic growth’ – but the implied guide from last quarter is 6% organic growth…mgmt might have just said “we only grew 0.1% and did a deal to obfuscate it – while getting closer to the inevitable covenant breach.’ I’m not trying to defend what I’ve said will be the best short of my career just to save face. The timing of this release is shady, the facts are ambiguous, it looks very desperate and pushes one of the most levered balance sheets in retail. Remember it blessed FY cash flow in the first week of December last year before the books closed three weeks later and it missed the year by $140mm. I wonder how well the CFO vetted this given that he’s got 2 weeks left on the job. Balloon under water – deep – might burst before it comes up for air.

There’s my banter…here are the facts regarding the release and our (otherwise know as Jeremy's/Daniel's) response.


Revenue/Organic Growth

  • Revenue estimated to be in-line with guidance at $1.80bn.
  • Last year's acquisition impact on this Q likely materially exceeded the $10mm guided by the company, no color on this yet, so exact organic growth is not known.
  • The messaging around organic growth has been cloudy.  If you run the math on the specific guided numbers on the 2Q print, the implied growth ex-acquisition to get to the full year revenue mid-point is 1.5% in 3Q, 6% in 4Q.  The company has been verbally saying 2.5% in each quarter, that only gets you to the bottom end of guidance range. 
  • The company did say it "returned to organic growth", which seems to imply a positive number, but below the stated 2.5%, or guided 1.5%.
  • Also, the comment “Our sales and EPS results, driven by stronger-than-expected international growth, are expected to be consistent with our guidance” leads us to believe that upside was driven by higher than guided acquisition benefit – ie deals were in Australia and Europe.
  • Also, the positive inflection in FX is a 1.5% topline tailwind in 2H by our math, which management has very much downplayed.
  • Bc HBI did another deal, you can argue that we won’t see the real growth of the real underlying entity for another year. But this thing is tiny. The acquisition adds $70mm, or 1.1%, according to the press release.  We would note that Alternative Apparel was reported to be nearly $100mm in sales in 2010. In other words, it’s shrinking.
  • Looking ahead, since it appears that HBI missed organic growth this Q, the implied 4Q is likely now 7%-8% to hit the previous guidance.


Margins/Cash Flow

  • Margins look fine this Q.  We think a sales miss will be needed to see margins underperform this year, which we haven't seen yet due to acquisition "outperformance" on organic growth misses. Keep in mind there is a 170bp margin tailwind due to the Nanjing plant closure this year (Gildan subsequently hired displaced employees).
  • YTD Cash flow was noted at approximately $330mm. That means 3Q beat the street by 7%, and was down 12% vs last year. 4Q has to do $345mm (down 13% yy) to hit CFFO guidance.  4Q cashflow looks more plausible, but we still think 4Q EPS will be a miss, and the company is lapping a huge inventory cleanup in 4Q with flat inventory while layering on 15 pts of acquired growth.

 
The Announcement & The Next Guide:

  • The company announces an acquisition, and gives prelim 3Q numbers, 2 weeks before the print, without commenting on the full year, with a new CFO that started 2 days ago.
  • The big question is what does it signal about guidance on the 3Q print?  We think it favors a negative revision or reiteration (ie negative organic revision with the acquisition).  If the company had good news, why not give it with this announcement?
  • Perhaps the new CFO wants the opportunity to gather all the data before issuing guidance, but then why not hold this entire release until Nov 1?

  
The Acquisition

  • Alternative Apparel is expected to have sales of $70M this year (1.1% growth to HBI). 
  • The size of the deal is not big enough ($200mm+) to push up the leverage covenant to 4.5x for another year.
  • Started in 1995, it sells Alternative brand better basic T-shirts, fleeces, other tops and bottoms. Alternative is a lifestyle brand known for its comfort, style and social responsibility. It’s American-Apparelish, but with no scale.

  Multiple/Synergies

  • HBI is paying $60mm (0.85x Sales) for the company.
  • The post-synergy multiple is expected to be approximately 3.5x EBITDA.  Based on previous acquisitions, we think most of the synergies management is counting on are sourcing and transportation. 

  Distro

  • The company’s sales and growth are split between the embellishment channel, the retail, online and direct-to-consumer channels.
  • Items are sold at Gilt, Nordstrom, the company stores/website and at a discount from screen print distributors (see image below)
  • It operates three stores.

 Sourcing

  • Alternative Apparel outsources all of its production.  Hanesbrands does not manufacture any of the items, and doesn't have the capability to make this type of product.  Everything from the textiles to the dyes to the cuts are different. It could maybe use internal sewing facilities, but this is all variable labor (no utilization benefit). 
  • If it takes manufacturing in house, it would be with lower quality material thus destroying the product differentiation and brand value. Sales would go negative.  The more likely rationale is that Hanesbrands believes it can source it from a third party cheaper than Alternative does because it has a dedicated buying office.

HBI | Balloon Under Water - Hbi CHART