Q4 details
- Gildan reported adj. Q4 EPS of $0.41 in line with consensus expectations. We were at $0.43 due to our channel checks that suggested distributor destocking would be less than expectations. They were, but sock sales were weaker.
- Sales declined 11.3% vs. consensus expectations of -9.3%. Adjusting for a sales allowance of $19mm sales declined 8.8%, essentially in line with expectations. Activewear sales declined 15% while Hosiery & Underwear sales increased 1%. Sock sales continued to be weak due to the exit of a dollar store program, but underwear sales grew DD% benefiting from the additional floor space for the George program at Walmart.
- Adjusted gross margins contracted 70bps. A payment to Under Armour for missing contracted royalty minimums was a 50bps impact. The contractual minimums were revised lower so the ~$3mm payment is expected to be one-time (UA confirmed the non-repeating nature in its Q4 call).
- SG&A improved 80bps and declined 17% YY due to lower incentive payments and the company’s cost savings plans.
Sales allowance
Management said they were reducing the SKU count which results in a $19mm sales allowance in Q4. The impact on COGS is $12mm. Gildan is reducing its SKU count by 40-45%. The small dollar impact for such a large SKU count reduction points to how much of Gildan’s sales are concentrated in its major product lines. There will be some small lost sales impact from the reduction just as there will be from the discontinuation of the direct ship to the piece business, but overall margins will benefit. We expect there will be a sales benefit by reducing the complexity for the manufacturing operations to better chase demand.
2020 guidance is better than we thought
We were surprised that management guided 2020 EPS to $1.85-1.95 vs. our expectation of ~$1.85. The higher end of the range does include share repurchase, but so did our estimates. Management also did not include any impact from the coronavirus. China is only a LSD% of sales and would likely get a pass for the virus, but it doesn’t reflect a “kitchen sink” approach to guidance. Either management didn’t learn their lesson on guiding the Street or underlying screenprint trends give management more confidence than they had last quarter. We think it’s the latter. Gildan’s guidance for 2020 also assumes a return to sales growth for the screenprint business in the second half of the year despite seeing an inflection in trend at the end of Q4 continue so far in Q1.
Fashion or end demand?
Management said the current weakness in screenprint POS is almost entirely in the cotton basics category. Gildan’s other categories of fashion basics, American Apparel, Comfort Colors, fleece, and international are all trending up. Within cotton basics the heavier weight 6 ounce G2000 line of shirts are especially weak while the G5000 mid-weight 5.3 ounce shirts are down much less and have bounced back recently. Management previously attributed the sales declines in screenprint to a drop in corporate demand in the promotional end use. Gildan’s distributors have told us that Gildan has lost sales due to lacking inventory even in the second half of 2019 when sales declined. When we try to reconcile the two explanations we come to our conclusion that the sales declines are more due to a market shift away from heavyweight cotton basics to lighter weight t-shirts (including fashion basics) more due to fashion and style preferences than to a change in demand by one segment of the market. In other words management appears to be imputing that corporate demand is weak due to a drop in sales of the G2000 line of shirts. At the same time management is aware that there could be a fashion shift. We believe the sooner management can alter production and inventory levels to the changes in demand the quicker it will return to growth.
Estimate changes, but the upside remains
We are taking our 2020 EPS estimate to $2.08 from $2.15 to reflect a shallower sales recovery in Q1 and Q2 due to SKU rationalization. Swapping a 2021 Q1 which has projected sales growth with the Q1 in 2020 where sales are guided to be down HSD to LDD% points to a current EPS power of $2.30+. We think shares are attractively priced at 12x a run-rate with sales and margins set to recover. Our 2022 EPS estimate is still at $3+ reflecting the next stage of growth from the Bangladesh factory expansion. A 17x multiple on that EPS estimate represents 80% upside from the current price.
