Outstanding quarter at face value from GIL. While EPS was in-line, it consisted of 13.6% top line growth – its best growth rate in 16 quarters – and grew EBIT by 37%, FCF by 52%, and put up the best SIGMA trajectory I’ve seen from any company this earnings season (by a country mile). The elephant in the room was 1Q guidance, which we stated on numerous occasions would be a disappointment. In fairness, the 1Q guide was even worse than we modeled – as the company is culling more low-margin business than we expected. Also, my sense is that customers put in extra orders in 1Q ahead of cotton-related price increases. In the end though, a solid move by management to streamline its book of business. When I first saw the guide I thought it would be a bad stock day (like, down 5-10%), but the reality is that this company is playing the best offense as it relates to controlling the trajectory of its top line into higher margin businesses than we’ve seen this entire cycle – and #growthaccelerating is a tough theme to come by as it relates to names tied to the US Consumer. That explains why the stock is holding up so well on the guide. We’re taking down our 1Q and 2019 estimate by a dime, but are keeping our 2020/21 estimates in-tact – where we are 25% ahead of consensus. GIL remains our Best Long idea, with a clear roadmap to a $60 stock over a TAIL duration, and a de-risked near-term earnings trajectory.
Black Book Link: GILDAN | 2-YEAR DOUBLE INTACT
Here’s Biolsi’s Review and Key Takeaways of the Quarter
Headline Q4 Results
- Q4 adjusted EPS of $.43 in line with consensus. I was at $.44. Guidance was $.42-.44.
- Upside in revenue growth was offset by lower gross margins. Clearing inventory of non-go forward product was a margin drag. SG&A was also down more than I modeled.
- EPS guidance is $2.00-2.10 with consensus at $2.10. EPS growth in the 1H is guided to be negative. Specifically for Q1 EPS guidance $.24-26 vs. $.34 LY and consensus of $.39.
- The reasons for the Q1 decline are what we outlined, but the magnitude is greater. Q1 sales guidance is down mid-to-high single digits. I was looking for 3% growth. The culling of low-margin socks and Mossy Oak is most of the difference – though I suspect that the company pulled forward orders as customers looked to avert the price increase.
- For the year EPS guidance of $2.00-2.10 is in line with what I expected to hear, but still well below my model. I expected the range of guidance to encompass consensus expectations at the high end.
- As for 1Q…I was modeling $.02-.03 lower than consensus with the expectation that management would likely guide somewhat lower than what the company would eventually report. Instead we got guidance $.14 lower than consensus for Q1.
- The variance to my estimate is primarily lower revenue due to four main causes. 1) Management said the Walmart program transition is a $15mm headwind to Q1 revenue. 2) Further declines in socks ($40mm annualized) is another headwind. 3) A stronger dollar is a $5mm headwind. 4) Finally, anniversarying the restocking in the printwear channel is a $50mm headwind in Q1. Last year Gildan destocked the printwear channel by about ~$60mm as it tried to get production to meet demand after disruptions in Honduras led to unanticipated factory downtime in 2017. Combined the headwinds are behind management’s mid to high single digit revenue decline projections in Q1.
- If part of the revenue upside in Q4 was the result of a buy forward ahead of the latest price increase it helps to put the revenue guidance in Q1 in a better light. Management may not know the extent that the price increase accelerated sales in Q4.
A better sales mix
- The culling of low margin businesses is happening in the context of larger revenue growth opportunities that the company is able to capture in the near term than in any time arguably since RN5 was opened.
- Management is still pruning low margin business in 2019. Exiting certain programs including Mossy Oak, a dollar store sock program, and the AKH Embellishment business is more of a drag in 2019 than I projected. This is a result of the division reporting structure consolidating between the Printwear and Branded Apparel divisions. With both business units reporting to President Mike Hoffman the company is taking a different approach to lower margin retail revenue. Instead of viewing the low margin retail programs as stepping stones in order to win additional activewear programs management is placing a higher priority on the current margins. Ultimately this will result in record margins when the capacity utilization is full.
- On the manufacturing side this is leading to the closing of the AKH Embellishment facility that was acquired with Anvil. AKH screenprinted orders for certain retail programs like Disney. Strategically Gildan does not want to be seen competing with its screenprint customers.
- AKH was also used to produce fashion basics performance product which was much less efficient than the new RN6 facility. Exiting low margin sock programs resulted in excess sock capacity. Rio Nance 3 will now be converted from sock manufacturing to dyeing. This will likely free up room in the other plants to add equipment that would increase unit production.
- Sales growth of 13.6% was driven by activewear growth of 22%. I was estimating 9% vs. consensus 9.3%. Hosiery and underwear sales declined 8%.
- International growth of 30% kept pace with the 28% growth in Q3.
- Fashion basics growth is likely only limited by the available capacity at this point.
- Global Lifestyle brands is the third revenue driver which gets less attention at this point, because the book of business is still going through transitions as Gildan optimizes Anvil’s business based upon margins and factory utilization.
- Gross margins contracted 80bps. I was looking for 20bps upside vs. consensus of +100bps. This looks disappointing to the Street, but it is the reality of its cotton costs and pricing lags. Management guided gross margins to be flattish in 2019 with a contraction in the 1H driven by the lagged impact of higher cotton costs being consumed in COGS. Price increases also have a lagged impact as prices on previous orders are recognized.
- I still expect gross margins in the second half of the year to be above management’s guidance as lower cost cotton, price increases, the mix benefit of fashion basics, and the benefit of exiting low margin programs all contribute to an inflection in the 2H.
- SG&A was down 8% YY and leveraged 300bps. Operating margins expanded 230bps
- FCF +52% and CFFO +38%. For the year FCF was up 23% to $429mm. Inventories declined 0.6%. SIGMA looks solid.
- I’m modeling another year of similar FCF generation. Gildan has proven to be a disciplined acquirer in recent years compared to its previous efforts to boost growth at retail with sock acquisitions. If an opportunity does not arise in 2019 I think Gildan will reduce the share count by 5%. This is after $125mm in capex spend that likely surpasses capacity additions for its relevant competitive set combined.