HBI: A ‘Do Nothing’ Stock

 

Near term visibility is good, and momentum picking up. But the company should be paying down debt instead of taking acquisitions. Also, we need to bank on seamless production out of new Asia plant and a healthier US consumer to offset headwinds 3 quarters out. Translation = do nothing…for now.

 

Overall, we’re no more or less inclined to own HBI in the wake of its 4Q. Is business getting better? Yes. Inventories are cleaning out while sales accelerate and margins appear healthy. Cash flow looks good – to the point where management is starting to mention ‘the A’ word’ (acquisitions).   The fact that it can think about acquisitions is good, but actually conducting them is not. Let’s face some facts here, HBI has too much debt in a commodity business that is undergoing a massive offshoring change while we’re seeing the greatest Macro cross currents in – well, just about ever. Let’s pay down some debt boys.  Earnings over the next 2-3 quarters look good, as higher cotton costs seem to be offset by previously announced cost cuts. But by 4Q, cotton exposure remains, and we need to bank on the Nanjing textile facility (which started up in 4Q) to be a fully ramped contributor to the business in order to give certainty for 4Q and 2011. In the meantime, the stock is not particularly cheap at 11x earnings and 8x EBITDA based on F10 estimates. For now, this is a ‘do nothing’ stock.

 

 

HBI 4Q FY09 Earnings Call

 

Quarterly Highlights:

  • Reaffirmed 2010 outlook
  • 5% sales growth
  • FCF of $300mm+
  • EPS 25%-35% growth yy
    • Strength in Innerwear - sell-throughs up end of Dec and in first 3 weeks of Jan
    • Pricing likely if cotton stays above $0.70

 

P&L Notables:

  • Sales down 4.5% (up 1% excluding 53rd week in F08) reflecting:
  • Innerwear +5%
    • Innerwear retail sell-through was flat for the quarter: slightly down in Nov, turned positive in Dec with the last two weeks particularly strong, seeing slightly positive sell-through for the first three weeks of Jan.
    • Direct to consumer +5%
    • International +2%
    • Hosiery -1%
    • Outerwear -6% 
  • Gross margins up 181bps reflecting:
    • price increase, cost savings initiatives, and lower cotton costs
    • more than offset the $13 million in incremental trade spending
  • Cotton costs for the fourth quarter was $0.47 per pound, ~$18 million benefit
    • Expect cotton costs to be $0.52 in Q1; $0.59 in Q2; and $0.73 in Q3 (should be able to offset with cost red.)
    • If cotton stays in mid-$0.70 in 4Q of 2010 - pricing in play as they have done before  
  • SG&A up 1.5%up 140bps yy reflecting:
    • Media + incremental $4mm ($10mm higher than last year)
    • $9mm benefit from cost savings offsetting $9mm in pension exp. 
  • Tax rate reduced to 12%, due to a higher mix of offshore profit
    • primarily as a result of domestic restructuring charges and the fourth quarter debt refinancing costs
    • Income tax rate, excluding actions, in 4Q was 3% 

 

  • Nanjing textile facility started production in Q4 and is right on plan
    • plant takes 18 months from start to be up to full production
    • will see impacts beginning in Q4 10 and all thru 2011 
  • Haiti is causing some short-term disruption in incremental costs - will not have a material impact on growth 
  • If inflation becomes systemic, strong brands give HBI the ability to price
  • Have already seen prices move in the industry and this trend may continue  
  • Beginning to think about acquisitions much more seriously and will share thoughts on criteria, priorities, and timing in February
    • Target acquisition price between $100mm and $300mm, must be domestic due to credit term  
  • Direct-to-consumer was previously included in innerwear chg'd with HBI’s strategy to drive retail sales with both the Hanes and Champion brands
    • Direct to Consumer in 2009: 1Q = $38 mil; 2Q = $49mm; 3Q = $53mm; 4Q = $48mm

 

Balance Sheet:

  • Inventory down $242mm (18.7%)
  • Paid down $284 million of debt despite cash outlays of ~$75 mm related to refinancing
  • Flex in leverage covenants - no restrictions on domestic acqs. Or share buyback
  • Pushed debt maturities out to 2013 to 2016

 

 

Outlook:

FY2010:

  • Sales growth of approximately 5% due to shelf space gains
  • Began shipping the new retail programs for 2010: These programs should result in 5% sales growth or approximately $200 million
  • Space gains should generate sales growth of approximately 6% in the 1H and 4% in the 2H
    • If consumer spending picks up, there could be upside to the 4% 2H est.
    • 2 months with the largest increase are March and April
    • growth by quarter is challenging because $20 million to $25 million can easily shift between months
    • By segment, 2/3 of the increases are to come from innerwear, and most of the remainder in outerwear
      • Innerwear gains will come from men’s underwear and intimate apparel. The new programs in men's underwear have already begun to ship, with the new intimate apparel program starting to ship in Q2.
      • Outerwear segment growth will be driven by the expansion of Just My Size in 1H. In 2H, Champion has confirmed space and distribution gains in fleece, performance apparel and sports bras across a broad set of accounts. Production capacity has increased to support growth
      • Both direct-to-consumer and international businesses should also see mid-single-digit growth and both have the most long term growth potential.
      • The remaining growth in the back half of the year will be driven by replenishment of these new programs
  • Goal to improve OMs 50 to 100 bps through costs savings (even with potential commodity price inflation), SG&A savings, and pricing
  • Goal to partially restore media spending from $80mm in 2009, to $90mm in 2010 and eventually back to historical $100mm
    • Interest expense should decline $20 million to $25 million
    • EPS growth of at least 25% and up to 35% or more in 2010
    • To reach the higher levels, HBI will need a little help from the consumer, possibly a little price, and an effective use of the potential $300mm or more of cash flow (domestic acquisitions)
      • See the potential for over $300 million in free cash flow
      • Expect tax rate to be in the 20% to 25% range for 2010 

 

Q&A:

 

  • Top line guidance: “feeling really good about 2010 and growth” retailers are in line right now, and increase in consumer spending would result in more inventory demanded by retailers 

 

  • Late 3rd quarter, early 4th quarter potential acquisition. 100 million to 300 million purchase price, not in negotiations, but looking out for the year

 

  • Era of apparel deflation is over, expect inflation, summer or by 4Q will see pricing take effect

 

  • Nanjing plant doesn’t contribute to production until the back half of the year, the process takes 18 months to get fully running and will only begin to see impacts of supply chain at the very end of 2010.

 

  • Great global low cost supply chain and can leverage it with adding volume from acquisitions
  • Small acquisitions of a couple million dollars are definitely possible and HBI is actively seeking it

 

  • Price increases: starting to see this and could raise prices in the back half of 2010, competitors are increasing prices which are matching HBI’s price increase from last year.  Men’s underwear industry pricing: Fruit of the Loom is $0.50 lower than HBI, private label is $0.50 cheaper than Fruit of the Loom. Oil and Asian wage pressures are potential risks that management is focused on for cost push inflation.  Relative to competition, HBI is very comfortable going forward if apparel industry experiences moderate cost inflation. Mix is favorable in 2010 with innerwear increasing.  Mix is one way to offset inflation cost pressures.   

 

  • Consumer Spending: watch weekly sell thru, inner wear category is their best read on the consumer, saw inner wear stabilize in September, weak in November, strong in December, especially on the back end.  1st 3 weeks of January are slightly positive, appears to be maintining the positive momentum from December.  Summer and beyond is when they are “hopeful” of consumer spending really pick up.  Starting to see a small but noticeable shift from low tier department store sell thru to mid-high tier, not a large move, but consumers are starting to pay up a tiny bit.

 

  • Shelf space gains: Good strong positive momentum. “Momentum breeds momentum.”

 

  • Long Term Growth Rates: will discuss in February at investor day conference

 

  • Gross Margin: additional volume increases will leverage supply chain, but management said to wait until February for more comments there

 

  • Strong shares in mid tiers, mass, and department stores: JCP taking men’s underwear for the first time, any channel shift is not a disadvantage because they have about equal share in mid tier and mass.

 

  • Categories: international and direct to consumer business are the 2 categories with the most room to grow long term. 

 

  • 8% of sales is traditional department stores, Macys is an opportunity, in JWN with hosiery

 

  • 5% revenue guidance is due to the space gains HBI has to make, if there is consumer spending gains that will be to the upside. 

 

  • Cap ex is much smaller than it ever has been because they have built out so much over the time.

 

  • Haiti: 2 buildings are structurally sound, 3,200 employed, 2,000 back today, 40% levels back up, will recover by early March, other plants across multiple hemispheres stepped up to cover the difference so there was no material impact.  Flow of goods is functioning out of a different port for the short term.  Only t-shirt production occurred in Haiti and only 5% of total sales.  Donated $2 mil of product to Haitians to aid the situation.

 

HBI: A ‘Do Nothing’ Stock - HBI S 1 10


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