GIL | Operational Leverage Cuts Both Ways

This quarter showed the tremendous amount of operational leverage inherent to the GIL financial model. Sales were down 71% from a year ago with Activewear sales of $132 million down 80% and sales of hosiery and underwear of $98 million down 28%. Gross margin was negative – I repeat…negative. Not even just fractionally, but -65%. The good news is that such leverage works both ways. We were impressed with how the company took down its cost structure (down 6,000 people in manufacturing and 380 in SG&A/admin) and how well it managed inventories and working capital – FCF was +$177mm for the quarter, which was a major plus. SG&A was down 30%, which was partially driven by furloughed employees, but also permanent cuts. SKUs for the quarter clocked in at 10,000, down from 30,000 a year ago – which is about is huge of a SKU reduction I’ve ever seen from any company that plays in the world of retail. Recall that inventories were lean in the channel due to destocking in 3Q/4Q of last year, and now in 1H they destocked further. While it may take two years to get to pre-covid levels due to the gradual resumption of things like concerts, sporting events, and other events where printed t-shirts are sold (and given away) the reality is that inventories are so lean that demand won’t creep back, it’ll snap back. And with that comes the margin. Capacity is back up to 70% of the utilization levels from pre-covid but demand is running down 15-20% -- which is not only cash flow-bullish but adds further torque to the gross margin line. In the US imprintables channel, we saw POS decline to lows of down 80% in April before starting to pick up in May as reopenings occurred. Averaging down approximately 50% for the month and then ending quarter in June down in the 20% range compared to last year. Importantly, management noted that distributors are in good shape, as they have managed their businesses for cash and drawn down inventory levels – but risk of them going away is low (even reported a recovery of previously-booked bad debt expense of $6mm). For this year, Gross Margin will be lucky to see 10%, off from 27% last year. We’re modeling a sharp snap back to 25% next year on 50% revenue growth, which gets us to $1.00 in EPS. The following year, we get additional covid-catch-up demand, plus the new Bangladesh facility comes on line (which all in is delayed by about six months), which bolsters International growth. Even with a rebound in opex, we’re still getting to EPS near $2.00 in 2022.  All in, we think that the path to ‘recovery earnings’ for GIL will happen faster than most of its peers, and the stock is trading at just 7x our TAIL earnings estimate of $2.40. If we’re right on the rate of recovery, the incremental returns on this model will put it in the top decile of retail – which is something we can’t ignore. You’ve got to be patient with this one, but we’re currently looking at trough earnings and a trough multiple on recovery earnings. GIL is a 2-year double from $17.