Our Best Idea Long side just got better. Slight headline beat – but that’s not what I care about right now. Gildan announced that it is launching a major expansion in manufacturing capacity in Bangladesh. The crux of our thesis is that new capacity brought on in June will be filled faster and more profitably than the company is guiding or the consensus is modeling. The first new capacity add in five years is happening at the same time two demand-driving forces are converging – a) the accelerated shift in retailers towards private label, and b) the emergence of the ‘fashion basics’ category in its screenprinting business. Not one of the 20,000 apparel manufacturing plants on the planet can match Gildan’s low cost structure – and therefore it can literally cherry pick the best and highest margin opportunities. My only TAIL concern on the story is that it will fill its new capacity over a 2-year period, and would therefore then mean-revert to a low-mid single digit growth rate – a multiple compressor. But with today’s announcement, a 2-year growth story just turned into a 5-year story. We’re maintaining our above-consensus estimates for this year and next, but are taking up our growth estimates by 500bps in years 3-5 of our model. This stock has been bullet proof, and at face value doesn’t look cheap at 17x earnings and 12x EBITDA. But the Street’s numbers are wrong. You win on earnings growth alone on this name, but with this capacity expansion announcement, the ‘winning duration’ just doubled – which is likely to result in a re-rating. The path to a $60 stock over 1-2 years is much clearer (and easier) today than it was yesterday. Reiterate Best Idea Long.
BIOLSI’S CALLOUTS FROM THE QUARTER
Gildan reported Q1 EPS of $.16 vs. consensus of $.15 and guidance of $.14-.16. I was at $.20, but that was because I thought the receivable write down for a customer’s bankruptcy was over-reserved. Instead the company disclosed an additional smaller bankruptcy charge as well. Adjusting for a larger write down results were in line with our expectations. Importantly Gildan beat me where I prefer the beats to come from – sales and gross margin and had higher SG&A and interest expense than I modeled.
On the surface EPS of $.16 vs. $.34 last year is nothing to get excited about. The results vs. guidance were boring in a good way. What is worth getting excited about are the company’s new capacity plans. Management has hinted at that with the announcement of an analyst day later this year to outline capacity plans. I think investors just aren’t giving enough credit to management’s growth plans. Consensus revenue estimates imply that analysts do not expect the company will fill its newly expanded factories by 2021. Today management just announced they spent $45mm during Q1 to purchase land to begin a new manufacturing complex. Management has proven in the past that they do not simply build capacity with a “Field of Dreams” strategy consisting of “If you build it, they will come.” Instead management has built capacity after counting up enough lost revenue opportunities to proceed with new capacity additions.
Big growth plans for Bangladesh
Gildan announced the purchase of a sizable land parcel in Bangladesh for $45mm. The site is expected to include two large textile plants and sewing facilities. Initial production is expected to begin in the latter part of 2021. The manufacturing complex is expected to service over $500mm in sales. Due to trade treaties Gildan can sell apparel into China and Europe duty-free from Bangladesh. Management has recently said that it will only have $500mm of spare capacity a year after opening RN6. Currently Gildan’s Central American factories supply Europe and Asia with $150mm of capacity. Once Bangladesh comes online that frees up $150mm of capacity to supply the North American market. So half of the first stage of capacity growth in Bangladesh the company can already count on. The other $150mm management has penciled for screenprint customers in Asia and Europe. Management’s visibility comes from knowing product categories, customers, and markets they currently do not supply.
Management has taken a very measured approach to expanding in Bangladesh. Gildan’s first expansion outside of the Western Hemisphere was through the acquisition of Shahriyar Fabric Industries in 2010 for $15mm. The plant had capacity for nearly 2.2mm dozens or an estimated $50mm in revenue. Over the years Gildan has expanded the plant while learning about the country and training the Bangladeshi management team in its production methods. In the past year management switched their new factory plans from Costa Rica to Bangladesh. It was not a rushed decision. Management will likely go into more depth into the decision making process at the analyst day, but the growth in Asia must be a critical factor in the change. Gildan’s Central American plants do not have the duty free access into Asia that Bangladesh does. Ringspun cotton capacity is likely also a factor that management alluded to on the call. Securing ringspun capacity is not something investors have spent a lot of time assessing, probably because it does not appear to have impacted the competition. For Gildan ringspun capacity is just as important as capital, labor, energy, and transportation access.
Gildan initially guided the impact from the Heritage Sportswear bankruptcy to be $21mm. The actual impact was $21.7mm for Heritage and $2.5mm for the bankruptcy of Payless. Based on court filings in which Gildan said it was owed $8mm for products previously sold and $8mm of inventory still at Heritage. I was only modeling a $16mm accounts receivable write down. I did not anticipate the Payless bankruptcy which may not have been broken out if not for the larger Heritage write down. Gildan supplied Payless with private label socks.
Walmart private label
At the end of Q1 Gildan started shipping $10mm of private label underwear to Walmart earlier than expected. Based on analysts’ questions it seems like there was still concern that the program would have much lower margins than the branded program it replaced. It’s my understanding that Walmart was happy with the cost (margin) of the Gildan branded program. The decision to switch to its own private label is part of an effort to reduce online price comparisons and not driven by increasing its own margins. Importantly Walmart is incentivized to grow its own private label program and I would expect the partnership to expand to other categories in the next couple of years.
- Revenue declined 3.6%. Activewear revenues were down 4.1% due to lower levels of distributor restocking in advance of price increases last year.
- The Hosiery and Underwear category revenues declined 1.8%, better than I expected as shipments to Walmart ($10mm) happened earlier in Q1.
- Gross margins contracted 140bps due to the lag in price increases to offset the cost of higher priced cotton. I was modeling in a much larger negative impact from the lag in price increases. Management reminded investors on the call that price increases are to offset raw material costs. Gross margin expansion is due to improved efficiencies. That plays a big part in why Gildan is both the low cost leader and why it has been such a share taker. I am modeling gross margins improving sequentially throughout the remainder of the year.
- SG&A was flat YY and deleveraged 50bps. Management’s cost savings initiatives have limited SG&A dollar growth to $4mm since Q1 of 2017.
Outlook from here
For Q2 I expect Gildan to return to its growth algo – MSD% top line growth, ~50bps of margin expansion, and a boost from share repurchase to drive LDD% EPS growth. Then an upbeat analyst day diving into revenue opportunities and capacity expansion plans. This will be followed by a swing in commodity costs on margins leading to accelerating EPS growth in the back half of the year – which is when we see an acceleration in top line due to new capacity fill.