An impressive headline, but what do you expect when masks and gowns(PPE) comes in about $500mm higher than the company signaled. Adjusting for $600mm in PPE in Innerwear and $150mm in International vs our expected $225mm the revenue number actually missed our model by $100mm or 8%. Innerwear slightly better, Activewear and International worse. Very bearish quarter for Champion. It's odd to think that now the company will be facing a $900mm to $1bn (or more) headwind on revenue at solid margins lapping this PPE. We weren’t expecting that normalized earnings in 2021 could actually be down from 2020, but that looks very possible now, rate of change bearish. There are some bullish data points, and some bearish in the print, but in aggregate the positives were likely priced in heading into this event. Taking a step back, US underwear in the last recession slowed 1000bps, contracting about 2.5% in ’08, and 3.5% in ’09. With such power stimulus this year, perhaps next year is the one to be worried about as it relates to consumer health and ability to consume. Why shouldn’t we expect a multi-year contraction in underwear in this recession? Our estimates are going up a lot for 2020 (modeling an extra $650mm in PPE will do that), but for the wrong (non-investable) reasons. 2021/22 moving up just slightly. Fair value $8-$10, downside to $5.
For more thoughts on HBI and why we think this is ultimately a single digit stock, see our black book from earlier this week, HBI | A Battleground Stock Again Link: CLICK HERE
Innerwear
Innerwear headline looks like it beat by 100%+, but that is where the company is booking personal protective gear. The important line in the segment commentary “Apparel performance, excluding protective garments… segment revenue decreased 27%.”
That means ~$600mm in PPE booked this Q in Innerwear, seeming to be mostly government contract related.
There are definitely some bullish data points in the Innerwear comments, noting improving POS trends and positive growth in May and June and 300bps of share gains, though we think all of those were generally previously known from market POS data, and with high volatility in the retail ecosystem perhaps the data has less accuracy than normal. Both private label and Hanes have gained share vs Fruit of the Loom, the question is whether its permanent or can be sustained. There’s opportunities for that to be the case under new management, but we think it has to be at a lower margin profile after some reinvestment.
Moving from down 29% in April to up 8% in May and up 11% in June.
Note the only quantified commentary on rate of change improvement in July is on intimates (flat in June to +3% in July), which leads us to believe everything else has slowed in July (Innerwear and Champion).
Activewear
Ugly quarter for activewear, down 62% and over 30% worse than we were modeling. We noted in our call that the Champion bullishness seemed misplaced given distribution changes and door closures. Champion globally was down 46% this Q, after down 12% last Q.
Champion comments on point-of-sale noted acceleration from down 14% in April to up nearly 40% in May and up more than 70% in June. Note July cited a strong/favorable, but not quantified, likely implying slowing.
Perhaps US is stronger than international, but the Champion revs are hard to reconcile with POS comments. You’d think last 2 months of +40% and +70% while the P&L having -46% means there would be almost nothing left in the channel, but there seems to be plenty in many of the stores.
Something seems off here, though we do expect sales improvement for HBI’s sell-in for 3Q.
International
International was also worse than our expectations. Excluding the ~$150mm in PPE sales were down 45%, roughly 15% off our number.
We would expect this segment to materially improve as Europe has been re-opening, but we would caution that the biggest international country Australia (~12% of total revs) was cited as performing well in 2Q, and likely has slowed materially under the virus second wave as management noted some store closures there.
Masks Long Term?
The company is estimating an annualized $200mm-$300mm recurring business opportunity in masks. We wouldn’t be surprised if that is translating what the company is seeing in non-government demand this year.
That would put a masks at about a third of the size of Men’s underwear. We think masks will become a real part of consumer apparel accessories, but as it relates to HBI, we’re not yet sure what the real business opportunity is here, but were thinking something closer to $100mm(or less) in rev potential, at much lower margins than seen this year.
Here are a few considerations:
- Right now it’s the wild west. The consumer’s willing to pay way more than in a normal supply and demand market, government overpaying under health necessity, so the market will be smaller with lower margins than we see today.
- The TAM isn’t everyone. Some people don’t believe in masks (~25% of US from latest surveys we’ve seen), another portion will favor disposables, some people (like glasses wearers) will require ones with nose wire, (which it seems HBI isn’t making).
- There are a ton of operators in the segment today, and certain manufacturers will specialize in it, we think HBI is better served focusing on its underwear/apparel core.
- The vast majority of what Hanes designs and makes is made to be worn out of sight of others. For the consumer market, masks will evolve to be more ‘attractive’ or 'accessorizing' than the plain white underwear look Hanes current models have. That gets out of HBI’s core manufacturing capabilities.
- Then do we think there will be as good a replacement cycle as other apparel categories. Or once you have your 5-10 masks (for those that will go with reusable) are you good for a while? And once the virus is behind us, do you just save the ones you got for the next virus, or when you feel sick?
- Lastly, is what GIL said on masks today: "We're doing our part in terms of helping local governments with masks and gowns as part of our initiatives in terms of COVID. But you have to understand, is that a long-term opportunity for us? I mean masks pre-COVID we're selling for $0.03 a piece. Today they're selling at $1.50. So there's a lot of capacity that's coming online and in Asia particularly. We think that's not a long term sustainable business for us."
Balance Sheet
PPE seems to be a savior to the balance sheet in 2020. Looking at nearly a billion in sales at good margins this year, the company is keeping net debt pretty stable with what looks to be another ~200mm in working capital in-flows early in 3Q. Inventory is already pretty lean, so we’ll see if cash generation in 2H is enough to start reducing leverage. Current leverage about 4.5x our 2021 EBITDA. The revised debt covenant levels of EBITDA now seem shockingly low given what the company might have known on the PPE opportunity.
Note: Street numbers likely marching higher than this on elevated PPE.
