I’m sticking to what I said yesterday morning in advance of the print. There are always puts and takes to every quarter for every company (except UA – all takes), but the reality is that HBI’s message is more opaque than ever. 4Q guide down, setting up for another guide down in 4Q – or a flat out miss. We should see this over and over, miss after miss – or one of those visceral 1-day collapses in the stock. Covenant issues. Special charge mean reversion, and margins cut in half. Trading at 11x EBITDA – higher than p/e. That rarely ends well. This is my best short by a country mile.
Let’s see if management responds to my email request asking for public debate on why I’m wrong in the stock price going to zero. Over/under on that? Anyone?
Here’s what I said yesterday in Hedgeye RetailDirect into the print. HBI #failed on nearly every account.
1. HBI earnings day. No backing off on the pre-print jitters. HBI already preannounced the third quarter – so it’s all about the 4Q guide. First conf call for new CFO Hytinen from TPX – prob won’t get too far over his skis. Unless the company gives me proof that there will be a meaningful acceleration in operating/free cash AND real organic growth in the US (and globally) then I remain comfortably short this name into the single digits. Actually, I don’t need proof. I simply need management to show me that it is playing – and winning -- a game of strategic chess vs the entire softgoods supply chain when its ability to fund real – and even acquired – growth is simply tapped. I don’t think management is lying – I think it has a flawed plan it actually believes.
Note…Management’s plan is as incohesive as ever. Management appears to be clinging to tweaks in nearly every line of the P&L and balance sheet to ‘reiterate targets’ without sufficient ammo. Either that or it’s simply leaving a lot of gas in the tank to surprise on the upside in 4Q, to be fair. Hey, it happens – and nothing is absolute in this tape. BUT, Based on our math around organic growth and capital deployment pushes and pulls (and likelihood that HBI is perhaps the only company in Consumer that will have to pay MORE taxes if tax reform passes), I’m comfortable being short today, tomorrow, and into 2018 while we continue to debate the story with the Bulls – and yes, plenty still exist (and bears are not bearish enough)
-- McGough
Here’s McLean’s ‘tear up the model’ overview that he sent to me late last night
This print seems very familiar. On the print for 3Q of last year the company guided to the low end of its full year range. The expectation was that 4Q was achievable. After all, revenue compares were very easy and management said they would meet targets... History repeats itself.
With share loss continuing across businesses (perhaps excluding Champion), we think 4Q expectations are high. Management is guiding to 3% organic growth still a bar it has not cleared in a given quarter in 4 years.
The conference call ended abruptly after a disconnection. It seems management left some questions unanswered.
Here are ours...
1. Did business really grow organically? Does not appear to have been the case. Here's why…
a. Does Pacific Brands (Hanes Australia) still exist?
HBI noted $15mm in acquisition impact in the quarter, and the same number coming from GTM benefitting Activewear. But, remember that Pacific Brands closed 2 weeks into 3Q last year. There should be 2 weeks of revenue benefit that is still acquired. Is the company implying that Pacific, a supposed $650mm business, had zero revenue in the first two weeks of the quarter? We would think the contribution should be in the range of $20-$30mm. Revenue was up $38mm yy. Pacific and GTM could have had $40mm in acquired impact, and…
b) What exactly was the currency impact on revenue?
Our math puts it around 1% in total top line in 3Q. The company simply said that organic growth was over 1% with c$ growth "roughly" 1%. Until we have clarity on Pacific impact and FX, we see organic growth as -1% this Q.
c) How are you holding share in basics with innerwear down 5%?
Management noted it is holding share in basics. This seems unlikely given that innerwear was down 5% in the quarter. We’ll be interested in Gildan’s comments on unit share in men’s underwear later this morning.
d) What do you expect 4Q International growth to be? And will we see improvement in US?
3Q international growth exceeded our expectation. This is another area where the missing information (precise FX benefit and Pacific Brands' 2 week contribution) would be very helpful for modeling clarity. Using our FX and Pacific estimates, we get to the organic growth for international at 7%. If that continues, it’s a ~2% organic tailwind that will have to try to offset the US declines, where both Innerwear (-5%) and Activewear (-2.4%) are running negative organically. The benefit from Alternative Apparel seems to be downplayed slightly, but at about just a 1% sales bump, the delta from our estimate does not appear material.
2) Why weren't gross margins higher?
Gross margins were up 19bps, below our bearish expectation. Our math puts the potential margin opportunity from closing the Nanjing facility at about 170bps. The company arguably cannot realize that full upside, but we were expecting about 50bps benefit. Gross margin fell below both our and street expectations.
3) Is this really a step up in marketing?
The company is guiding that it will invest in marketing to drive sales which is hurting 4Q profitability leading to the guide down. We wonder if this is really higher investment, or just getting back to a normal rate after the company pulled back in 2016 with marketing down 7% at the same time the company added ~$800mm in new business that are overweight retail vs the core. We were expecting SG&A deleverage in 4Q, and we continue to think revenue will disappoint even with higher marketing, leading to margin weakness.
4) How is the tax rate going lower?
Tax rate was 2% in this quarter with help from discrete items, contributing an extra 3 cents in EPS vs the 6% running tax rate. Management is guiding 4Q to be 5%. We're not sure how the rate is trending lower, nor do we know how low it can go. We do know HBI's tax accountants are worth every penny. This is one company that could potentially have to pay MORE In taxes if tax reform passes. Yes, really.
5) What levers do you have in working capital in 4Q and what do you expect the cash flow benefit of Alternative apparel to be in the quarter?
As we already knew, cash flow looks good. HBI re-iterated FY, which we largely expected. With the newly acquired cash flow lever the company will pull hard to try to make the CFFO number. Guidance implies about $120mm in working capital benefit in 4Q. It seems difficult given that inventories have already been cleaned and the company is working against a significant inventory cleanup in 4Q of last year. The make-up of inventory reported in the 10-Q should give some additional insight. The impact of Alternative apparel should be small, but the company has a history of acquiring cashflow to help the CFFO line.
6) Hello?
This was the second conference call in a row that went dead in the middle of Q/A. This instance included several minutes of classical music while getting management back on the line. Poor execution for an $8bn cap company. The call ended about 12 minutes earlier than normal, including the dead air. Normally the company gets to 13 or 14 people for questions. This call only got to 8. Since no new questions were taken after the delay, a conspiracy theorist could argue that the Q/A queue was lost on disconnect and the operator or company chose not to ask for the analysts to re-enter. In all likelihood, someone intended to hit mute on the polycom and hung up instead. It happens. Twice.
