The ‘emotion factor’ is coming back to this stock after a year’s vacation. Duration is very important here, and our views differ based on near vs. intermediate vs. long-term.
HBI is an interesting name right here. It has historically been a ‘love it or hate it stock” with not a whole lot of sentiment resting between. That high-emotion factor deflated over the past year, and it fell on to the ‘who cares’ list – based purely on investor requests to us on the name. Now we’re we’re seeing the emotion build up again on both sides. We view Duration on this one almost as a barbell.
We like it a lot near term – for the next two quarters, that is. The company has the top-line in the bag, cotton costs locked 30% below current prices, moderate channel restocking, and channel fill as a key customer – Dollar General – is back in rapid growth mode and will need HBI product to fill its shelves. Over the longer term, HBI is the last company left in the industry that can capture such a major margin delta through sourcing savings and use it as an offensive weapon to gain share the same way Gildan did in the early 2000’s. We only need 2-3% growth to make that happen longer term, which would drive margins up and debt down.
But can the company sustain a 5-8% top line growth rate? No way. This is an underwear company, folks. Units grow at about the rate of population (ie 1%) and there’s no real pricing power to speak of. The channel fill is important and undeniable. But just because the channel is refilled (and perhaps overfilled) does that mean that the end consumer will wear more underwear? Nah… I don’t think so.
So what’s our concern? It’s that after we pass by these 2 slam-dunk quarters, then we have to bank on 1) sell through, 2) an improving consumer, 3) rational behavior by Wal-Mart in the wake of channel fill at other retailers, 4) that the Asian factory transaction goes as planned, and that either cotton prices come off, or HBI can offset them with pricing power.
Can all of these things happen? Yes. But our point is that they HAVE TO happen.
Our conclusion? Be mindful of your duration here. Over the next 2 quarters, it’s going to be tough not to like HBI – 3-4 quarters out is a different story. Once that risk passes, $3 in earnings share is a complete reality here.
Key Highlights from 2010 Analyst Day:
Int'l Growth Strategy:
- Can leverage the Int'l business by integrating local business into global supply chain - overhead on par with local competition, but sourcing a distinct advantage.
- Expansion in Mexico since 2008 has been a very positive model that HBI can follow in other markets - expect to introduce outerwear in Mexico now that innerwear/essentials business is established.
- #1 in Canada, Mexico, and Brazil, but significant gain potential in both China and India
- China and India only markets with a double-digit growth profile versus low-to-mid single digit growth for other regions
- Focused on core apparel categories
- Not diversifying
- New channels
- New platform/geography
- Min integration risk
- Fund from FCF/ reduce leverage
- Accretive Yr1
- $200mm deal size
Multifaceted Savings Strategy:
- Expect $150mm in savings over the next 3yrs
- Network = $45mm
- Distribution/Logistics = $30mm
- Start-up & Rest. Eliminations = $20-25mm
- Purchasing = $30mm
- Optimization Initiatives = $20-25mm
- These savings will drive 50-100bps in annual operating margin expansion
Detail on $150mm in savings:
- Slightly more in 2010 compared to 2011
- 60% in GM; 40% in SG&A
- Cost of goods improvements driven largely by maturing supply chain network
- more indirect purchasing and distribution savings
Cost inflation out of Asia - what's built into HBI's assumptions:
- Have built in some wage inflation
- If cotton up another 10% will take more costs out
- Locked for Q1 = $0.52; Q2 = $0.59; Q3 = $0.73
- Assume $80 oil (Q1-Q3)
Revenue growth organic vs. acquisitions:
- 2-4% long-term growth excluding acquisitions
- Domestic opp'y is first choice for acquisitions
- $100mm goal for media spend annually
- Plan is to reinvest - may hamper 35%+ growth in EPS in order to drive growth
Shelf space gains update:
- Ahead of internal sell-through plans to date
- Finished by summer
Sales/ft. versus current productivity?
- Gains at WMT = 4ft.
- Dyed underwear & t-shirts not quite as productive as core white tee
- Mexico model gives mgmt confidence
- "trade advantage" - tap into treaties low duty movement
- Key to moving upscale and into newer channels
- Expect ~$90mm spend in 2010 with goal of increasing to $100mm/yr to grow with sales
Acquisitions - "superior returns":
- Focus on cash on cash returns
- Significantlyabove debt reduction + share repurchase
- Not much exposure to Europe
- "in the 1st inning"
- Stores currently ~60% of direct-to-consumer mix, will shrink as internet grows
- Strategy is less location growth than location expansion (footprint) - designed to capture greater $/cust, not necessarily drive increased volume
- Adding brands in existing doors
- Assumption in 2010 - minimal (any increases would be based on Q4 costs at most)
- Beyond 2010 - predicated primarily by cost inflation
- 2-4% top-line outlook for 2011+ assumes very little by way of pricing
Outerwear - Operating Margin growth opportunity:
- Will be primarily driven by supply chain savings as well as mix
- where smaller volume business is brought in-house
- More branded product
- Will be below company average over time
- Was ~12% in 2009 - due to large domestic restructuring charges/ refi
- Expect 20%-25% over next 2-3 years
View on 'commodity business':
- Mgmt is focused on growing branded lines, which are more differentiated and defensible vs. the commodity business
- Does not suggest they will neglect wholesale customers
- Looking to leverage the supply chain to offer branded apparel and build out the screen print channel
Supply Chain - Opportunity to Internalize:
- Currently outsourcing lower run product lines where there is less leverage opportunity
- In the process of internalizing the Champion's C9 line
- Spoke to ideal of $200mm in size
- "some companies acquire as a growth strategy, but that's just not us" - Rich Noll
- Won't lever up for growth via big acq.
Intimate Apparel - Shapewear trend:
- Have plans in place
- See some gains in 2010-2011
- Didn't meaningfully impact the business in 2009
- Less than 20% of the mass market
- Starting to see same trends as in most retail where retailers are focusing on #1 and #2 brands and adding private label to shrink moderate brands
Cotton - regional purchasing:
- Bulk is purchased in the US
- Very small quantities out of China
Chinese facility (Nanjing)- Capacity Utilization:
- Will continue to expand 1st phase through early 2011
- Building can be doubled from current build out plan (essentially 50% utilization)
- Phase 2 of build out will be to develop other 50%