HBI followed the same old playbook we’ve seen the last couple years. Print EPS headline in-line, with some charges and tax help that mean it’s an underlying miss. Then guide down 1Q while promising a stretch hockey stick in full year earnings and a kitty of non-GAAP charges. HBI is definitely not ripping off the band-aid, rather going for the slow painful hairpulling style as we’ve seen it do for several years now. We’re not sure why year in and year out HBI will set a bar that it truly struggles to beat organically. Innerwear missed as expected. Champion was solid at +22%, a bit better than we expected, though slowing from last Q, but improving on a 2 year basis. Guidance looks like a stretch, perhaps it adds some more charges to make the number like it did in 4Q. $50mm being guided for the year and $27mm in 1Q. The problem we have with guidance is that we have no idea where the profits come from with the signaled sales losses. C9 details were kindly given and it was exactly as expected. 23% Activewear margins, 1000bps above the rest of Activewear, and 35% Innerwear margins (despite management implying that margins for Champion and C9 were similar). That means you need nearly 2x the Champion sales to replace the C9 EBIT. That would be ~$800mm in incremental Champion. Good luck with that (as Champion is being guided to grow only 10%). Innerwear is guided to be down, but improving throughout out the year. Again Innerwear carries high decremental margins (where will the guided EBIT come from?), and we suspect it will miss the expectation again as it has for several years straight as it will be down more than the guided 1.5%-3.5%. That’s more EBIT pressure vs the guide. Lastly as we have highlighted previously, there is a real risk Champion inflects to negative in 1H 2020. If that happens, this stock will rapidly test new lows towards the single digits.
Best Idea Short.
For our HBI Short Black Book from October: CLICK HERE
Guidance Procedure
We noted in our note before the quarter that it was unclear who would be in charge of guidance, the CFO, IR, or the CEO. It appears we got our answer from commentary on the call.
In the Q/A the CEO stated: “And we are pleased with the fourth quarter. Our record cash flow and double-digit EPS growth, and our in-line guidance really speak to what we've been doing to improve our business model.”
Notice his reference to “in-line” guidance. We wouldn’t be surprised if the order from the CEO to the interim CFO was guide EPS in line with the street number making the components look as plausible as possible. This comment gives the appearance that the targets are not created based on business plans of the segment leadership.
Separately in that same quote, the CEO refers to double digit EPS growth (in 4Q). That is true if you are looking at the GAAP numbers with this year seeing a big tax benefit, but it’s not true for the adjusted numbers. If we are talking in GAAP numbers, then HBI did not guide “in-line”.
Re-basement?
The company provided detail on 2019 results with C9 and the DKNY intimates business removed. This was very helpful, yet we think the reason why is to talk about results in the coming quarters as if C9 and DKNY never existed. We suspect we’ll be hearing about steady revenue and profits in the coming quarters despite them actually declining materially. It’s almost like a retailer closing stores and the changing commentary to pretend those stores never existed. Yet ending C9 was not HBI’s choice, and it’s in talks to re-launch the brand in a much smaller partnership later in the year, which is part of guidance (but not debasement numbers?).
“Through the remainder of my remarks and for comparison purposes, I'll be referencing our rebased 2019 results which adjust for the exits of C9 at Target and our DKNY intimates license. This will provide a clearer view of the underlying trends within our business. Using the midpoint, our 2020 guidance implies approximately 3% revenue growth.”
Innerwear Expectations
The one area where HBI seems to never properly set expectations is Innerwear revenue, which happens to be the most profitable marginal business. This year if you go back to where the street estimate was based on initial annual guidance, HBI missed the annual number by 1.5%. The Innerwear guidance once again looks at least that much too high. Management said it was being conservative in its guide, but it said that last year as well.
4Q 2018 - “Despite our improving fourth quarter trends, we decided to take a more conservative view of our U.S. Innerwear segment for 2019”
4Q 2019 - “And while we continue to plan conservatively with respect to our U.S. Innerwear business, we expect improved revenue trends in 2020 in both basics and intimates.”
The guidance is for -1.5% to -3.5%, which apparently after the lost C9 Innerwear (~2%) is +1% to -1% after re-basement. If the trend in innerwear has been down 3-4% for several years, how is flat being conservative?
And the down 3-4% the last 2 years is with the major customers (WMT & TGT) seeing great traffic trends.
Macy’s closures will mean incremental distribution pressure (but apparently that’s in guidance), JCP is likely to file Ch.11 this year and close a lot of stores.
HBI seems to be implying it will easily replace C9 Innerwear with Hanes brand product. We have yet to see that in the stores and we doubt that will be the case, but TBD.
Lastly the company has indicated that the changeover of product presentation at WMT, which we have highlighted as a velocity threat (See George Gildan In-Store Presentation at this LINK), will actually mean increased shelf space. Again we doubt this, WMT will want to make changes to ensure the success of its private label George brand, not to give Hanes more shelf space. We’ll keep an eye on stores during the changeover to see if the shelf space statement has merit.
C9
This quarter was one where C9 didn’t drive some upside vs guidance (others this year did). The company kindly provided specifics by quarter on the impact as noted above. The results are $361mm in Activewear revenue at 23% EBIT margins, and $42mm in Innerwear revenue at 35% margins. This is as we had always estimated, a 23% margin, with the rest of activewear 13%, a 1000bps difference despite management implying multiple times in the past that Champion margins were on par with C9. Again we struggle with how those profits will be replaced given the revenue guide in the context of Innerwear being down.
The company broke news in the FAQ that it is talking a potential deal with a new C9 partner. Is it common to announce a deal when getting close to signing? Not after? As the company seemed to imply, and what we have thought all along, any new partnership wont be big enough to have a real impact on earnings.
Share Repo
The company announced a share repo. This is the only time we can recall a company announcing a repo plan based on the count, not the dollar value. That almost implies you expect the stock price to remain rather low. The company expects to repo $200mm worth early in the year. This total repo is taking up our tail EPS by about 10 cents.
Cashflow
Cashflow benefited this quarter from inventory and accounts receivable changes, with C9 phase likely playing a big role, and some help from lower raw materials. We flagged this in our note prior to the quarter. We think inventory needed for future sales, and raw materials increases should both be pressuring working capital and cash flow as the year progresses. We also wonder if the company is running out of room for any factoring while losing some of its receivables base and facing declining revenues.
Champion Risk
Champion was solid this Q growing 22%, slowing from last Q but on a tougher compare, meaning a 2 year acceleration. The company is guiding 10% growth in 2020 with MSD growth in 1H and low dd in 2h. That’s basically what we expected they would guide, but still think this could be high. Though we’re not modeling it yet, we think there is a real risk that Champion goes negative by mid-2020 given the over distribution and high domestic inventory levels in the channel.
Charges
It’s a bit like beating a dead horse with HBI, but the charges still seem ridiculous. It’s the only company where I have long term charges actually modeled in.
This quarter the company made the EPS number finding about another $8mm in “supply chain actions” and “program exit costs”. Assuming this refers to C9/DKNY, how do you have program exit costs in a quarter where the program’s did almost $90mm in sales? And when do supply chain actions simple becoming a cost of doing business?
This is one of the reasons HBI will maintain a very low PE multiple.
Expect Acquisitions
We flagged in our October 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. On the last call CEO Gerald Evans confirmed our suspicion all but explicitly saying expect M&A in 2020.
With Barry Hytinen leaving we think acquisitions become even more likely, as Barry seemed to be the driving force behind the “deleveraging” story that was communicated in early 2019 that temporarily scared away bears. Acquisitions may temporarily obscure the weak underlying fundamentals for HBI should they occur, but ultimately given HBI's style of M&A execution, we think the majority of deals we have seen and will see are equity value destructive and increase the opportunity short-side.
