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Takeaway: Champion – HBI’s biggest (temporary) revenue tailwind since the IPO was up 75%, and yet EPS only grew 1.5%. That’s just sad.

This was one of the best and most puzzling quarters we’ve seen from HBI in years. It put up its biggest revenue beat in 5-years, with Champion accelerating to 75% growth this quarter from 50% in 4Q. You would think that this would result in a blow-away EPS number – especially given all of management’s air time on margin levers and price increases…but no. Despite the biggest organic top line tailwind HBI has seen since going public, EPS only grew by 1.5%. That’s pathetic. At this point, we’d argue that Champion is turning into more of a liability than an asset. In fact, management noted that it should slow by almost half in 2Q in the US, and subsequently guided down the upcoming quarter in both revs and EPS. Perhaps a sandbag, but that’s why the stock is down today. Could we be here at year end having Champion ex-mass grow 40-60% and earnings not grow? Absolutely. If you’re a bull on this name – and there are plenty of them out there (short interest is at a 2-year low), be very careful what you own. This name is a melting ice cube. I continue to believe that it’s likely a survivor in #retail5.0, but there won’t be any value left for equity holders. One of our top shorts with the name in the high teens.

There are puts and takes for our bear thesis this Q, but let’s address the key questions investors care about on this name…

What is Champion growing?

  • Champion grew 75% (ex C9 which was down 3%) accelerating from 50% last Q. US activewear up 80% and Intl up ~65%.  That’s massive growth for a reasonably large global brand that’s been around for a century.
  • The interesting piece is that for the first time I can recall it gave some guidance specifics, indicating that Champion US Activewear would grow in the 40% plus range in 2Q.  That’s almost half the rate of 1Q.  Perhaps that is part of why the stock is down, that could be a risk short side as perhaps that increases the chance of “squeeziness” next Q if that number is a sandbag and ends up being 50%+.
  • The margin flow through of the revenue upside appears to be weak, as Activewear’s incremental margin was better, but still just 9%.  The company noted investments around Champion, but the comments seem to indicate necessary investments to support current revenue flow, not investments to drive future demand growth saying, “company invested in distribution to maintain service levels and fulfill accelerating demand for Champion products.”  Can that be easily unwound if Champion starts comping negative?
  • The company didn’t provide any details on Payless (which has a license to sell Champion footwear) until asked in the Q/A.  It said it’s a modest portion of the business and that losses will be more than covered by the upside in Champion as a whole.  Ultimately is still an EBIT drag, even if rather small.
  • Our next research steps on Champion are further vetting how much real upside there is in both US and European distribution.  US growth this Q was driven by comp sales and space gains in current doors, as well as added distro in US sporting goods retail.  The retro athletic fashion trend for Champion is working, we don’t truly know how long it will last or how big it can be.  But one thing we do know is what almost always kills a brand growth cycle, and that is over distribution without real investment in marketing, R&D, and product innovation to drive the next cycle of growth. +80% in a quarter after 2 years of outsized growth is feeling like overdistribution, while ad spend and R&D rates for HBI hit new lows last year.  That looks bearish to us, but more work to do here.

What’s Happening in the US Core business?

  • The US core business continues to struggle.  Innerwear was down 3%, Activewear ex Champion was down low double digits.
  • The bright side perhaps was basics were up LSD, and EBIT was up despite the revenue decline.  Only detail management gave was a better than expected net result from price increases.
  • Management is still in denial about the risk of Private label, noting that it displaced a private label sock program at a national value retailer (we don’t know who for sure, but our best guess is Family Dollar).  Management not acknowledging the risk here is not good if you are a bull.  Hopefully privately it has a real plan for dealing with what we see as a big long secular shift in mass retailers toward private label that is accelerating in 2019.

What’s happening in international?

  • The international performance was both impressive and somewhat surprising.  This is probably the most bullish callout relative to our expectations.
  • International in C$ was up 18% organically, and got $18mm in inorganic help from Bras N Things as well. Bras N Things was also noted to have comped up, which likely gave some extra margin help (retail leverage). With some of the detail given this Q the Champion business internationally appears more substantial than we have previously thought, as it had $290mm in sales this Q, up 65%.  Our initial sense is that Japan/Asia is bigger and growing better than we thought.
  • Outside of Champion, international innerwear saw declines in Europe but made it up in other regions.  HBI seeing solid results internationally with the global macro picture still well short of positive.

What’s the future of C9?

There was very little detail in the PR or call on the future of C9.  Management even seemed to dodge it a bit in Q&A.
The FAQ 8-K had a comment, and it’s not bullish.

Q: Can you provide an update as it relates to your plan for C9 after the January 2020 transition?
A: We continue to see significant momentum building globally within the Champion brand (excluding C9) and we are focusing our energy and resources on maximizing this business. While there may be an opportunity in the future to build the C9 brand with another retailer, we currently do not have any plans in place.

The company has no new agreement locked up with the clock ticking, the odds of C9 finding a new home are rapidly falling from where we sit.