Hanesbrands produces innerwear and activewear for sale in the United States and international markets. Its innerwear line consists primarily of the original Hanes brand. The activewear line is led by the Champion brand.
Currently, the sales breakdown is relatively even. Over the past several years, domestic innerwear sales have decreased slightly and have been offset by the faster growing activewear and international sales segments.
The business is simple to understand. Hanes makes money by selling its products to distributors, retailers, and direct-to-consumer. DTC is a substantially smaller part of the business, with the majority of sales coming from third-party channels.
Hanesbrands’s major competitors include other branded products and retailers’ private brands. According to NPD Group, the share of branded innerwear has remained constant or has growin in major Hanesbrand markets. In the United States and France, this share hovers round 90%. In Australia and New Zealand, it is around 73%. The CAGR for the world innerwear market is around 1%.
Unlike the innerwear segment, the activewear segment is growing and dominated by key players such as Nike and Lululemon. Although a small player, Hanesbrand’s Champion line shows solid growth and should benefit from the secular tailwinds in this market.
Q1 2020 showed that Hanesbrands may have a major tailwind to come out of this downturn even stronger. Hanesbrands’s current sourcing suggest they will be less disrupted by future supply chain reorganizations or trade barriers than private label brands and competitors. It’s main competitor, Gildan Activewear (NYSE:GIL), saw a quarterly decline in sales of almost 26%. Meanwhile, Hanesbrands only saw a decline of 17%. I believe a large part of this due to Hanesbrands’s minimal China exposure. According to the company, only 3% of its total COGS originate from China. Gildan has what I estimate to 75% of its greater Asia exposure concentrated in Chinese distribution and the overall apparel industry has 40% production exposure to China. Given the level of industry exposure to China, HBI is poised to take incremental market share going forward as private label brands and branded competitors struggle to refit their supply chains while Hanesbrands continues to execute on its existing strategy.
Hanesbrands seems like an excellent opportunity right now because it is a highly-levered consumer staples company trading at a cyclically-low apparel manufacturer multiple. However, Hanesbrands has a completely manageable debt burden and, unlike pure-play consumer discretionary apparel, Hanesbrands’s top-line is insulated by its innerwear segment and its new product line: personal protective equipment. Therefore, it will continue to generate strong free cash flow even in a depressed macroeconomic environment. This means Hanesbrands is a “public private equity” play in which cash flows used strategically in dividends, buybacks, and deleveraging that generate substantial ROE over the next decade.
The above cash flow build illustrates the strong margin-of-safety in this company. If I assume declining margins, revenues that never return to pre-crisis highs, declining EBIT multiple (below the current low of 8.2x), and poor capital allocation (no increases in dividends and no buybacks), we still see a positive IRR 5 and 10 years out. It seems the probability of permanent capital impairment is remote with HBI.
Management stated that sales are starting to recover week-to-week since April, a statement echoed by Gildan Activewear. Because of this, I don’t think sales will drop as precipitously as indicated by the above model. Here is what I think is more realistic:
We see a recovery by 2023 with a slowly growing top line. Historical margins remain in-tact. The company conservatively uses cash flow to deleverage, slowly raise dividends, and engage in modest buybacks. Finally, we see EV/EBIT recover to 10x, which is below median multiples prior to the crisis for basic apparel and is confirmed by backing out an EV/EBIT multiple from 2029’s projected terminal value. In this realistic scenario, we are seeing IRR nearing 20%.
I believe HBI has deteriorated significantly because of its already high leverage. The business is not only selling what are actually staples into a market that will cede share, but it is also experiencing a cushion from the sale of face masks. Once the market realizes HBI’s future cash flows are not impaired and we exit the downturn, HBI will regain a proper multiple and return capital to shareholders throughout the life of the investment.
Update: I exited this investment on July 27th for approximately a 50% gain over a couple months.