HBI print was much as we expected, headline EPS in-line on slight revenue beat. Though, we’d call it a penny miss as C9 was supposed to be down 15%, and it was slightly positive, which meant an extra 1 or 2 cents in earnings vs what was guided. That matters since C9 will soon be a discontinued business (January).
Champion slowed significantly on a 1 and 2 year basis. Gross margin missed, down 53bps, even worse than we expected. And EBIT returned to decline after 4 quarters of increases YY. With all that, the company guided up 4Q slightly. We struggle to see how the company will hit that guide given how we understand the model, but even if they do, on the next print the company will have to guide to 2020 where we see numbers as being 20%+ too high. HBI remains our top short.
For details on the call see our Black Book from last week… Link: CLICK HERE
Innerwear
- Exactly as we expected Innerwear missed with 51% decremental operating margins. The company is guiding it to get better in 4Q, we expect it to get worse. More details on that below (4Q Guidance).
- In case you haven’t noticed, HBI has missed Innerwear revenue 12 of the last 15 quarters.
- Cotton is now a margin tailwind (guiding GM% up 100bps in 4Q), but as we hit on in our deck, when WMT/TGT start to hear your company gross margins are guided up 100bps largely from lower input costs (cotton/oil) after price increases were taken at the beginning of the year because of the cotton rise, they likely want to reverse that price action soon for the customer, eliminating the tailwind. That’s a risk on 2020.
Champion/Activewear
- Activewear missed with C9 positive (it was supposed to be down 15%). If C9 higher than expected is how you beat 2H this year, good luck in 2020.
- Champion slowed to +26% globally, from 54% last Q, 1300bps slowdown on the 2 year. If you straight-line the 2 year trend you got -10% growth in 1Q, that’s a big risk.
- The odd part of Champion is the growth by category. International was up 24%, domestic 29%. Ok, but then Champion Activewear (a domestic business) was up only 18%, slowing massively from 54% last Q. That means Innerwear had to make up the variance in growth, implying domestic Champion innerwear was up close to 150%.
- We consider Innerwear growth less healthy as Activewear growth (after all it’s not really visible), not to mention Innerwear still missed with this kind of strong growth in Champion Innerwear. (Basics, including men’s underwear, women’s panties, children’s underwear and socks, intimate apparel, such as bras and shapewear, but NOT sports bras).
- The margin was up again this quarter, again C9 grew, and the company is exiting ‘commodity’ (margin dilutive) businesses in Activewear. So there is still no evidence that Champion has equal or greater margins vs C9. We think C9 is materially higher, which is misunderstood from a modeling perspective, and a big risk as it goes away in 2020.
International/Other
International outperformed, beating expectations by ~3% it grew 7%, or 11% in C$. Margins were up slightly YY.
The company didn’t break down details on Champion like it had the last couple quarters, but our math suggests Champion was still over 100% of the growth in International. So growth is 'all' Champion yet the company cited growth in Innerwear internationally as well as in Bras N Things. It begs the question, what declined?
Other revenue grew 3% this Q, the second time in 11 quarters. Other includes US outlets, and hosiery. If you own this stock you don’t really want to see outlets perform well, maybe building Champion inventories in the US means some better product flow there.
M&A
We flagged in our deck that we would not be surprised to see acquisitions again when Champion revenue slows. After all, management incentives are aligned with doing acquisitions at any price.
Expect leverage to head up as CEO Gerald Evans confirmed our suspicion all but saying expect M&A next year...
“And certainly, we are most comfortable operating in that debt range of 2 to 3x net debt-to-EBITDA. From the standpoint of what that allows us to do it, it allows us to introduce both share repurchases and acquisitions back into our toolbox, if you will, to drive shareholder returns. And I think, we've done a nice job over time of balancing the two, and we will certainly continue to balance the two to drive the long -- the best return for our shareholders at the given time. And I think you should expect that acquisitions will be part of that mix over time.” – 3Q19CC
4Q Guidance
Credit to CFO Barry Hytinen for being so detailed on his guidance. We got nowhere near as much color in past years. Though we would have liked the quarterly detail on Champion revs by segment.
His guidance detail is the paragraph below. Keep in mind the company just missed Innerwear, missed gross margins, and materially beat on C9 – a business that will soon be gone.
Here’s what we think is missing or where we differ:
On Innerwear, a few things
- First C9 is expected to be down 30% in 4Q, if that translates to Innerwear and Activewear equally you have ~$5mm in Innerwear rev pressure.
- The underlying revenue trend is likely to be weaker than signaled. The company seems to be crediting a lot to the lapping of the Sears bankruptcy, however Sears is still a customer and sales are still in results, despite apparently not being in guidance, so the 4Q guide for Sears should be $0. There is less of a YY headwind, but we don’t think this is material enough to reverse the underlying trend, especially considering the difficult compare within Innerwear? Also, Sears closed 142 stores last October and now it is expected to close another 100 stores in the coming months.
- We think the shelf space losses and unit velocity risk inside WMT as part of the George underwear program launch continues to build in 4Q pressuring reorders for the Q.
On Activewear, the only part we struggle with is how margins will be up so much with C9 being down 30mm yy. Though the SG&A growth this Q and the implied guide do suggest the company is pulling back hard on investment, which is likely more bearish for Champion growth in 2020.
In International, guidance looks reasonable.
3Q19CC Q&A:
“For the total company, in the fourth quarter, our outlook assumes gross margin is up about 100 basis points and operating margin is up about 90 basis points, which equates to the $12 million more operating profit we have in the guidance year-on-year. Now I think the easiest way to explain that is to go right through the expectations that we have by segment. So on a year-over-year basis in U.S. Innerwear, we have both gross and operating margins up about 100 basis points, which, when combined with our sales guidance, is roughly $138 million of opening profit, which is an increase of $4 million year-on-year. I think a good way to explain how Innerwear expectation is developed is looking at it sequentially. As you'll see when comparing our fourth quarter guidance with the third quarter performance, the absolute sales level are basically the same and the pricing benefit is consistent. So if I explain Innerwear sequentially, our guidance would equate to about $16 million more profit in the fourth quarter versus the third quarter. And there are 2 drivers. First is, we have $10 million to $11 million of benefit due to improved supply chain efficiencies and lower input cost. And I'll note, we have very high visibility on those improvements. And then secondly, we'll have less promotional activity and better mix and lower expense, which is just seasonal, and those combine for about $5 million of sequential profit increase. And when you put that in your model, I think you'll see that it arrives at the guidance I referenced. Now within U.S. Activewear, our guidance assumes operating profit dollars are consistent year-on-year based on our sales guidance, which puts operating margin up a little over 100 basis points versus the fourth quarter of last year for U.S. Activewear. Now that's all explained through the remixing activity we've had underway in the segment to drive the improved profitability we've been seeing, which has really driven off the -- few factors. First, Champion is going to grow nicely again, and we're seeing strong margin improvement that will more than offset the decline we've projected in C9. We have the benefit from the exited commodity programs, I recall that was $20 million of sales last year with essentially no profit. And then thirdly, as we noted in the commentary, we've got a sales decline in our printwear channel based on how that channel is developing. And that's really a lower-margin portion of the Activewear segment. So that will get you to flat profit dollars in the quarter year-on-year. And internationally, we're using incremental margin on the $25 million of reported sales increase that would get to about $6 million more profit and we got about $1 million better from our other segment and corporate costs being consistent. And I think at this point, I'll just remind everyone one more time that at a total level for the company, brand investment will be equivalent year-on-year in the fourth quarter. So all in all, we have high visibility on the gross margin expansion, which with the good cost controls we've got underway will yield the increased operating profit that our guidance is calling for.”
