Hanesbrands (HBI): A Very Cheap, Very Leveraged Stock That’s #1 in an Industry that Changes So Little Even Warren Buffett Loves It
Hanesbrands (HBI) has gotten very cheap lately. In fact, the stock is back at prices that are pretty close to where it was spun-off from Sara Lee back in 2006. I talked a little about the stock back then. It was a spin-off I liked – I haven’t found many of those lately – and I’d assume the business has become more valuable over the last 14 years, not less. We’ll see if that’s true.
The business hasn’t changed much in 14 years. Hanesbrands acquired other businesses. It has grown in athleticwear. And it has grown internationally. However, a lot of this growth was acquired with the free cash flow produced by the innerwear segment. Hanesbrands divides itself into 3 parts: U.S. innerwear, U.S. activewear, and international. By my math, profit contribution is roughly 55% from U.S. innerwear, 25% from U.S. athleticwear, and 20% from international. All segments are profitable. And innerwear has seen shrinking profits over the last several years while international has grown (mostly through acquisitions).
Hanesbrands has a very strong brand position in U.S. innerwear and a pretty strong position in U.S. athleticwear. It also owns a lot of the top brands in various countries through acquisitions made to build up its international business. There may be some synergies between international and U.S. – but, they aren’t brand synergies. This gets into the issues I have with the company: 1) Acquisitions, 2) Debt, and 3) Management / Guidance etc. I’m not necessarily opposed to acquisitions, the use of debt, or management here. But, each of those 3 issues do complicate things a bit. For example, I’m not sure I like what the company has done in terms of acquisitions over the years – but, it’s hard to tell.
So, this is one area that changed over these 14 years. Originally, Hanesbrands seemed like it was interested in taking its core brands: Hanes, Champion, Maidenform, Bali, Playtex, Wonderbra, etc. and exporting them into other countries. This never seemed like a great strategy to me. Underwear brands are sold mostly as “heritage” brands. They’re like chocolate bars and breakfast cereal. There are countless countries around the world that have some very popular chocolate bar or very popular breakfast cereal that they’ve been eating since about 1900 or 1950 or whenever. They love it. The rest of the world hates it. It’s successful in their country. It flops everywhere else. Trying to convert someone who eats Cadbury to switch to Hershey – or trying to get an American to start eating Weetabix instead of Kellogg’s Cornflakes just isn’t going to work. These are commodity products. Do they taste a little different? Maybe. Is one brand of underwear a bit cheaper, a bit higher quality, a bit more comfortable, a bit more stylish – maybe. But, any of those things can and will be tweaked. Any company can invest in some different synthetics or different cotton, can do a slight bit of R&D work combined with a lot of consumer research – and they can copy what Fruit of the Loom is doing or Gildan is doing or Hanes is doing. Any brand can shift itself a bit in terms of cost, raw material quality, adopting some common innovations in the industry, shifting with some styles, etc. and get to basically the same place.
Underwear brands aren’t like watch brands. There isn’t much “positioning”. Hanesbrands estimates that the Hanes brand (its biggest brand) is in 90% of U.S. households. Sometimes this is in the form of men’s underwear, sometimes it is in the form of socks, or children’s underwear, or T-shirts, or women’s underwear. But, it’s in those households. That makes Hanesbrands something like Heinz. Is it the cheapest? Gildan might be cheaper. Private label might be cheaper. But, it could basically match anyone’s price if it wanted to. Heinz can make ketchup as cheaply as anyone. Is it the best? At each price point – it’s pretty capable of having as good quality as anyone else. I suspect Gildan can produce very low end men’s underwear at a better price / quality mix than Hanes can. However, Gildan’s brand is less well-known and it has to pay retailers to give it shelf space. The retailer buys Gildan underwear for less than Hanes underwear and then prices them the same. The retailer pockets the difference. Gildan probably has better production facilities and is more vertically integrated. It can certainly produce blank T-shirts for printmaking at a lower price than anyone – including Hanes. So, as a pure commodity produce – Gildan is the leader. It has the lowest cost.
But, it doesn’t have the brand. And being the lowest cost / highest quality producer of ketchup would allow you to take some market share (for example, you’d be able to supply private label ketchup) – but, it wouldn’t get you ahead of Heinz for #1 in the industry. It’s too late to unseat Heinz, because their brand is time. That’s the same with Hanes. Hanes doesn’t have any particular appeal to the athletic or unathletic, the rich or the poor, the young or the old. All it has is that it’s something you probably bought before and your parents probably bought before you were even making that purchase decision. All it has is that it’s literally everywhere. Hanes is generally the most accessible brand anyplace you’d shop for underwear. You can find it online, at Wal-Mart, at Target, at Kohl’s, in Dollar stores, in department stores, and even in sporting goods stores, some specialty retail, etc. Hanes is even a big supplier to the U.S. military. It’s everywhere. It’s good enough. It’s cheap enough. And you’ve heard of it before. You’ve probably worn it before. So, it’s not just a pure commodity – it’s a branded commodity.
The business doesn’t grow over time. It might be shrinking a bit. I suspect Hanes is losing market share in U.S. innerwear. It’s unclear where though. Gildan started selling men’s underwear – so, presumably, there has been market share losses there. However, from how Hanes describes growth trends each year – it actually seems like the losses in U.S. innerwear in recent years have come more from things like women’s underwear, socks, etc. than men’s underwear. Men’s underwear and socks are subject to less fashion risk than the various kinds of women’s underwear – bras, panties, hosiery, “shapewear” – that Hanesbrands sells. The decline in U.S. innerwear has been pretty slight. Sales were $2.5 billion in 2016 and declined to $2.4 billion by 2018. Profits went from $615 million to $530 million. That is definitely a decline. But, it’s not the decline in U.S. innerwear that concerns me – it’s the acquisitions Hanes has been making outside that area.
So, Hanes shifted strategies from trying to push its big brands in other countries to simply buying out the #1 or #2 brand in Australia, France, etc. Why do this?
There is a logic to it. Hanes is different from most apparel companies. It is a true manufacturer. It is focused on having low costs. In fact, 70% of all the physical unit volume put out by Hanes is produced in either a Hanes operated factory or a factory that serves only Hanes. The company doesn’t outsource most of its needs to companies that serve multiple manufacturers. To give you some idea of how much Hanes has invested in production – consider this: Hanes employs 68,000 people and owns 8 million square feet of production and distribution space, and leases another 15 million square feet of production and distribution space. That’s very different from most apparel companies. Hanes – also unlike most apparel companies – barely does any business with China. Something like 97% of the company’s products come from countries other than China. A lot comes from the company’s own factories in Southeast Asia (like Vietnam), Central America, and the Caribbean. The company has done away with all of its U.S. manufacturing.
So, these acquisitions do potentially make a lot of sense. Here’s how they work. You already own the #1 underwear brand in the U.S. But, the U.S. is only like 10% of worldwide underwear sales. So, you find another country that’s maybe 1/10th or 1/5th the size of the U.S. market – a country like Australia or France – and you buy the biggest brand there. You then shift how that brand was sourcing its product. So, you leave everything intact with customers it was supplying, the advertising it was doing, etc. But, now instead of buying from China or whatever they were doing – you shift it all to being produced in the same factories you’ve been using. Many of those factories are owned by you, staffed by your own employees, etc. You squeeze out economies of scale at the plant level. You take advantage of economies of scale you have on the cost side. You don’t really benefit from synergies on the revenue side – because, as I said, it’s tough to sell Hanes into Australia or France or wherever or Bonds into the U.S. if those names are totally unfamiliar in those countries. Hanes also licenses some fashion brands like Polo and DKNY for probably much the same reason. You pay the license. It’s another thing you can sell alongside Hanes in certain locations. And you’re producing all the stuff in the same factories.
Hanes’s accounting for these acquisitions is so messy it’s hard for me to know if they’ve gotten their money’s worth. This is especially true because Hanes doesn’t break out organic growth very well. The number is sometimes discussed. But, not consistently. So, I can see how much Hanes paid. But, then there’s this really, really big number for a one-time integration cost. It’s usually a huge number compared to the acquisition price. So, really, we should probably just add the one-time acquisition cost to the actual acquisition price to get an all-in price to evaluate the purchase. This doesn’t seem like just accounting gimmicks to me. The whole point of why these acquisitions might make sense is how you change everything on the production side while leaving a brand with a real national heritage in place. That obviously costs a ton. You are constantly restructuring something if you’re doing this all the time.
Would Hanes just be better off buying back its own stock?
Maybe.
The stock hasn’t always been cheap. But, it still seems to me like a lot of the earnings Hanes has is really coming from Hanes (and some other strong brands in innerwear) and Champion (which is mostly U.S. athleticwear – but, also is a somewhat international brand). So, a lot of this company really seems to be Hanes and Champion. It might have made sense to just buy back more and more stock to own more and more – per share – of Hanes and Champion. The prices paid for acquisitions when I add in the one-time costs seem high versus the market price at which Hanes itself has often traded in the market.
Regardless, the stock is cheap. Free cash flow does not dry up fast in this business. Hanes was loaded up with debt when it was spun-off. It’s loaded up with debt again (this time to make acquisitions).
The debt is presenting a bit of a problem here. But, maybe not too much.
So, Hanes just came out with a press release (about a week ago) saying they had drawn over $600 million on their credit line. They now have $1 billion in cash on hand. Hanes has obligations in 2020 though. And 2021 as well. This isn’t an exhaustive list. But, I’d say they have about $850 million in interest, rent, debt repayments, and minimum royalty payments due in 2020. The number is more like $1.15 billion in 2021. They also generally commit to some purchase minimums at the start of the year – almost no purchase obligations extend beyond the year though.
The actual debt repayment schedule is quite forgiving.
December 2022: $750 million
May 2024: $900 million
June 2024: $600 million
December 2024: $500 million
May 2026: $900 million
That’s a ton of debt. And there’s a lot due in 2024. However, I’m not worried about years that far out for Hanes. In fact, I’m not even very worried about 2021. Unlike most businesses, Hanes is really just exposed to actual economic shutdowns due to coronavirus – not to any recessions that follow. The business is largely replenishment. There is almost no change in U.S. innerwear purchases in recessions, depressions, etc. Athleticwear is different. And international may differ to the extent it’s not just innerwear. But, probably at least 50% of Hanesbrand’s free cash flow is basically recession proof. The other 50% is less sensitive to economic conditions than most businesses too.
What is free cash flow like?
This is the part that interests me. If we just take the 3-year average free cash flow – it’s $600 million. This is after interest payments, taxes, etc. That’s not bad for a company with $1 billion in cash on hand and the first debt repayment being $750 million in about two and a half years from now. Another way of doing it is taking today’s sales and applying the long-term average free cash flow margin. That also gives us a free cash flow estimate of $600 million. Hanes has withdrawn its guidance in the face of coronavirus. But, again, free cash flow guidance would have given us a $600 million and up figure. The guidance had been for $700 million to $800 million in cash flow from operations and Hanes’s usual cap-ex of about $100 million. Let’s call that $600 million in free cash flow.
So, just how much is that versus the enterprise value, the market cap, etc.?
Well, $600 million is just under one-tenth of the enterprise value of $6.3 billion. So, on an unleveraged basis – and I’m using an after interest payments FCF figure here instead of EBIT – we’d be talking about a “P/E” (really EV/FCF) of 11 or so. However, the stock is leveraged. So, the situation is a bit different for a common stock buyer. There are 358 million shares outstanding at a current price of $7.39 a share. So, the market cap portion of the enterprise value is just $2.65 billion. Or, to put it another way, $600 million in free cash flow divided by 358 million shares is $1.68 a share in FCF. The stock price is $7.39 – so, on a leveraged basis we’re talking about a price/free cash flow of 4-5 times. The leveraged P/E here is basically 4-5. One other way to look at it is that if I think HBI’s normal free cash flow (in say 2021 – or more like 2022) would be $600 million, the company would be comfortable paying a dividend of 25% of that amount. The company targets a dividend payout ratio of 25-30%. It could pay more if it didn’t acquire, buyback stock, and have so much debt to pay down. So, let’s take 25% of $600 million in FCF. That’s $150 million. Well, $150 million divided by 358 million shares is $0.42 a share. Let’s call that 40 cents a share. I feel pretty strongly that in a couple years HBI will be paying a dividend of at least 40 cents a share and probably raising it from there. Once they get on the other side of coronavirus shutdowns – a 40 cent a share dividend should be very secure. The company’s actual dividend at the moment is 60 cents. But, I’d assume they suspend that for a year or two (like a lot of companies will). Well, a 40-cent dividend on a $7.39 stock price is a 5.4% dividend yield. I really do feel that as long as Hanesbrands gets through the next 1-2 years, it’s almost certain you’ll be paid more than a 5% dividend that will maybe increase over time and certainly won’t decrease. That’d be a very manageable dividend for them.
Finally, I need to discuss the stock’s extreme volatility. This stock has had some pretty wild rides up and down over the years. A lot of that could be debt. Some of it could be perceptions I don’t agree with. This is not an overlooked stock at all. It has been written up at Value Investor’s club 5 times – 3 times as a long and 2 as a short. I read those write-ups. I disagree with all of them: both the longs and the shorts. I don’t think this company was ever much of a compounding machine. I’m not convinced the acquisitions done – mostly by the previous management – were that effective. I do think the company focuses too much on adjusted EPS figures instead of just reporting like organic growth and free cash flow. But, I also disagree with the write-ups (the shorts) saying this is a bad business, subject to all these potential declines in things, etc. It has really changed very little in the 14 years since the spin-off. The core business does not change quickly and does produce a lot of free cash flow. That free cash flow is consistently generated and pretty secure far into the future. It’ll be used for something: debt repayment, dividends, stock buybacks, acquisitions, etc. But, it’ll be used. So, I’ve always fallen in the middle on this one. It doesn’t grow organically. But, it’s also a timeless brand in a very unchanging business. There’s a reason Warren Buffett owns Hanes’s closest peer and competitor (Fruit of the Loom). It’s a business he has probably milked for cash without putting much of anything back into cap-ex, R&D, and advertising. I tried to figure out the maximum amount Hanes could really spend on those 3 things together – I think it’s never much more than 8% of sales and usually less.
The debt here is a concern. But, if you were going to put a lot of debt on anything – you’d put it on something like Hanes and you’d space out the borrowing as they have. A lot of the debt is fixed rate. I’m not sure if that’s a plus or a minus here.
There are covenants. And, like just about all businesses, Hanes will trip those covenants this year.
This is not a risk-free stock. But, it is very cheap – especially on a leveraged basis. And it’s definitely the kind of business Buffett would buy.
Geoff’s Initial Interest: 80%
Geoff’s Revisit Price: $4.00/share (down 46%)