Takeaway: Look past today’s rip. The underappreciated earnings power here should push a $55-$60 stock over 1-2 years. Best Idea Long.

The print played out spot-on with our expectations when we laid out our Best idea Long Black Book for GIL on July 19th as a 2-year double. If there is any change on the margin, it seems like management has pre-booked Rio Nance 6 capacity earlier in the queue than our (aggressive) model anticipated. For our video presentation with full investment thesis, CLICK HERE. Clearly the 21% stock move was a nod in our corner, but mind you that the stock was down 10% over the past week due to a sell side downgrade over concerns in Nicaragua affecting production – a call that was flat out wrong and skewed sentiment to the ‘super bearish’ side. I’d classify today’s trading as a simple right sizing of expectations on political unrest. But what is not yet rightsized are EPS expectations. We’re modeling a 5% EPS beat in the back half and then a sharp (25% CAGR) EPS ramp in ’19 and ’20 when the Street is still stuck in the teens. This name is feast or famine…it either trades at a low teens multiple on a ‘low growth tapped out capacity’ number, or at a high teens multiple on an acceelerating incremental margin/ROIC number – such as our 2-year $3 EPS power. There’s your $55-$60 stock in 2-years. If you think you missed it after today’s blistering run, you still have a lot of runway ahead of you.

--McGough

 GIL | Gotta Own This at $30 - GIL financials

Biolsi is my crack analyst on this one. Here are his thoughts on the numbers and key issues as written to me.

Revenue accelerating across multiple lines of business

  • What is doing better is the growth in activewear in screenprint channels in the US, fashion basics, business for retail brands, international, and private label contracts.
  • International was up 35%, accelerating from 24% in Q1.
  • Activewear accelerated to 17% from 3% in Q1.
  • Management did not provide much details, but the core screenprint channel has accelerated and is short product.
  • Gildan needs more supply to chase the opportunities in front of it.

Nicaragua concerns put in context of its vast global operations

  • Gildan has three of its 13 sewing plants in Nicaragua. There have been months of civil unrest and protests in the country. A competitor recently downgraded GIL citing additional costs and lost revenue. It is important to distinguish sewing plants from manufacturing plants as the assets of the former is largely the trained labor and nothing on the balance sheet. Shorts may have pressured the stock price into the earnings release. My thought was that any short term disruption would be seen as one-time in nature and limited in scope. Management did not even call out Nicaragua in the press release, but addressed it on the conference call. Gildan has had fires and earthquakes impact sewing production in the past that the company quickly mitigated. Gildan’s manufacturing operations are more global in scale and diverse.

Loss of shelf space fears overdone

  • Gildan is the first company that I am aware of that outlined the shift in the mass retail channel to carry more private label brands. There has been a lot of concern that Gildan was losing all of its shelf space at Walmart after the sock program exit. It is my belief that Gildan could have retained the sock shelf space as the private label manufacturer.
  • With the consolidation of its divisions management is now tasked with raising their margins in the retail channel. I believe the WMT sock business was one of Gildan’s lowest margin businesses. If Gildan does lose the shelf space for undershirts at Walmart it would be the leading candidate to be the private label supplier. It’s also unlikely that Walmart would transform the men’s basics offering to feature its own private label unless it were to retain more shelf space.
  • As the low priced item Walmart’s private label offering would be positioned to significantly increase unit velocity. (I have been taught to not underestimate the volumes that Walmart does at its lowest price points.) I think Gildan is more than willing to cede a small Gildan branded undershirt shelf space for much larger private label volumes.
  • I think the men’s underwear category could see a similar transition, but it is more likely a decision put off into the future for the following reasons: Gildan had been consistently gaining share in men’s underwear. Men’s underwear as a category is much less penetrated by private label and Walmart for one, is not a retailer that makes decisions without a lot of testing. If Walmart did decide to replace Gildan’s branded underwear business I think the same dynamics would hold as men’s undershirts.

Private label, embracing the market opportunity

  • Gildan announced three new private label programs starting in the 2H in underwear and fleece. I think there will be more to come in 2019. Note that Target just booted HBI’s C9, and will need to replace with either a brand or Private Label. My bet is that Nike ends up in there. If TGT goes the private label route – then GIL is the winner.  Investors are uncertain if private label is really an opportunity. Unlike its vertical competitors Gildan really makes its margins from the manufacturing part of its business not the branded markup. Gildan is the low cost producer in many of the activewear product categories. Private label margins weren’t the previous problem, it was socks in the mass channel. Seeking private label business might seem like another change in strategy for Gildan in the retail channel, but it’s really the acknowledgement of a changing landscape followed by an appropriate adjustment. Gildan is able to adjust, because its business is built on the foundation of being the low cost producer. If the bedrock of its business was a brand that wasn’t garnering investment it would be at risk of being consolidated like its closest competitor.

 GIL | Gotta Own This at $30 - competitor gil summary

The Rio Nance 6 ramp-up, faster than the market thinks

  • The question I get that surprises me the most is, “What gives me the conviction that production will ramp up?” It’s not simply that Gildan opened a factory so production will ramp up. It’s not that easy to take market share. There is more thought to opening a plant than say opening another bar & grill restaurant in a mall. Gildan has not opened a new factory since RN5 in 2012. Instead of a new plant in the last couple of years it built yarn production, which is non-revenue producing.
  • Gildan sees the demand opportunity for another factory exceed its minimum thresholds and that is why RN6 has just been opened. It’s not a coincidence that RN6 is opening when Gildan is chasing demand in its core screenprint channel, business is accelerating across multiple product lines, and RFPs for private label business are hitting their inbox. Management said they expect Rio Nance 6 to be at full capacity in a year. This is a year earlier than our model anticipates. The Street never assumed it would reach full utilization or revenue estimates would be in line with us instead of $500M below.
  • RN6 will primarily manufacture fashion and performance products which are seeing strong demand currently. Europe and Asia are also seeing strong demand which will be supplied from the Bangladesh factory. The fashion basics and branded retail business manufactured out of Mexico is also driving revenue growth. So it is the demand outlook from many of the company’s plants that gives us confidence in the factories ramping up to full production.

 GIL | Gotta Own This at $30 - gil 2 chart

Headwinds to management’s initial plan, not enough to prevent estimates going up

  • Management said there were 8 cents of headwinds that were not originally anticipated in the 2018 plan. Yet, management still raised sales and EPS guidance to the high end of the range.  The additional headwinds are from Nicaragua, the licensed sock business being weaker than plan, higher transitional manufacturing costs adjusting factory production, higher raw material pressure, underwear was down slightly, and American Apparel ramping slower than initial plans. It sounds like a litany of higher costs, but that is the strength of Gildan’s business model that it can adjust to various pressures and manage them through its vertically integrated supply chain.


2H visibility improves

  • The combination of the RN6 ramp-up and the new private label program adds visibility to 2H revenue growth of HSD%. The screenprint market continues to be short inventory with product shortages cited by distributors. Gildan is simply chasing demand and now it has the factory capacity. I’m modeling gross margins in the 2H to inflect positively from higher pricing and improved factory utilization. I’m modeling SG&A leverage to accelerate as the divisional consolidation savings begin to appear. How many companies can target the revenue Gildan is over the next two years and even be in the ballpark of flattish SG&A growth in this environment?

 GIL | Gotta Own This at $30 - gil sigma

 GIL | Gotta Own This at $30 - gil earnings algo