A big dose of reality this quarter for HBI. A headline beat of revenue and EPS, but coming with PPE help higher than expected, the usual HBI non-gaap charges, and a big guide down of 4Q earnings and cashflow. The bull case had been around basic apparel demand resurgence, shelf space gains and a bigger Walmart future with the new CEO, and Champion recovery. Innerwear inflected positive and basics were up 15% (note Gildan reported underwear up 21% last week), but with so much in sales given up in 2Q, and 4Q guided to slow, it’s well short of market expectations. The company mentioned shelf space gains, but the CEOs comments around brand re-investment signal that revenue gains will not come without a cost. Meanwhile comments on Champion sounded positive including a big sequential improvement and wholesale bookings for 2021 above 2019, yet the brand was still down 9% YY and it's not clear how long it will take to return to pre-covid levels, if it can. The messaging from the new CEO seems crystal clear that he intends to reinvest in the brands and likely take margins down for the foreseeable future. This is exactly what we expected, but not what earnings estimates had baked in. So with the core margins heading lower and the company having to compare against ~$1bn in PPE sales next year, the forward earnings outlook is decidedly bearish. We think HBI EPS is heading towards $1.00 and the stock around $8-$10.
The TREND
4Q revenue is guided to down 6% YY, and earnings per share to down about 45% YY. That includes some help from a 53rd week (which in 2014 was $34mm in revs and ~$5mm in profit). It looks like the company has set itself up for a 4Q beat, but the outlook on that event will likely be negative. Year over year the biggest issue is obviously lapping a huge volume of PPE, about $1bn worth, that we suspect was at above average margins. The core business should of course be better in '21 lapping the Covid hits, but we think it will be below 2019 levels, and margins will compress further as the company invests in the business. Inventories look elevated and the company noted higher than expected PPE inventories to be an issue for working capital, which perhaps means demand for HBI’s PPE goods is waning. The Champion brand is improving in sales, but still down YY. The company is highlighting higher wholesale bookings for spring/summer 2021 than it saw in 2019. That seems surprising given how big the inventory levels were at retail last year and we wonder what the quality looks like. 2019 saw sizeable Champion assortments at many of the more fashion focused retailers like Zumiez, Urban, Pacsun, Foot Locker, FinishLine… are the bookings more ordering from those? or is it higher orders for Kohl’s, JCP, Macy’s, Walmart online, off price? Or is something bigger/changing in international bookings? Wholesale pre-booking certainly isn’t everything for Champion but we’ll be curious to see how that data point plays out in stores and on the P&L next spring. Meanwhile, the brand in terms of online interest looks to be far from its peak and its screenprint/college exposure is a clear near term headwind.
The TAIL
On the bright side for HBI is the fact that this CEO sounds much more sincere and transparent about the business than the old Noll/Evans regime was. It also seems he has the right plan to get the business to a healthier position for growth, but there looks to be earnings pressure in the interim. Many of the comments he made supported our view that margins are going lower before growth will return. We think a margin reset to the area of 8%-10% is what we could see for the model as investment rises and business still limps along through the later stages of this pandemic. Here are some of the CEO comments that stood out:
- Become a more agile, consumer-centric, growth oriented company. We think that means higher R&D and marketing to drive better product quality and brand perception, as well as investment in supply-chain and infrastructure.
- Advertising rate of 2% is too low. Pretty self-explanatory, need more marketing dollars to drive demand.
- M&A not a priority. The prior management team had been doing the acquisition and margin milking strategy which created the leverage issue and core brand weakness we see today. Good to see that is not the way this CEO is going, instead opting for organic investment and organic growth.
- “One of the main reasons I came here was the opportunity to work on Champion and with the potential that it has”. CEO appears to have some big aspirations with the Champion brand, that’s good, but with the brand now seeming to cool down from its peak 12-18 months ago it will require capital to reaccelerate growth. Given this is an old brand that has died and reemerged several times and has been recently riding a broader retro athletic trend, management might want to be cautious with the magnitude and pace of investment.
- Private Label is absolutely a threat. This is in direct contradiction with the message the former CEO Gerald Evans communicated, and it’s the correct one. He followed up by saying retailers expect brands like Hanes to be traffic drivers and the retailer expects the brand's consumer focus to support that, again signaling higher investment/advertising levels. Spend up to create value/relevance for the consumer and retailers will of course give you more shelf space, you just can’t do that at a 15% operating margin as a global basics brand.
The CEO appears to have the right strategy and mindset, but he has a lot he wants to do to re-build HBI. Margins will have to go down before quality growth returns. Meanwhile, the company’s leverage situation means investment can’t be done rapidly given covenants, so we could see a 2-3 year period of declining/depressed margins.
