Description

We believe the 1H 2022 decline in Gildan’s enterprise value from $8bn to $6bn provides equity investors a chance to own a high quality company that will produce attractive risk adjusted returns over the next few years.  We view Gildan as a safe and defensive long-term compounder run by great management.  The company is judicious with its capital allocation strategy, balancing share buybacks with capacity expansion.  The company’s enduring moat is rooted in its lowest cost manufacturing capability, which drove market share gains within its industry over the last 15+ years – we expect this to continue.

Other business attributes include: +25% ROICs; strong balance sheet (1x levered); owner-operator with a > $100mm stake; no China exposure; currently strong underlying business fundamentals. 

The drop in enterprise value during last 6-7 months is entirely attributable to a drop in the stock, although Gildan’s forward EBITDA & EPS forecasts are up meaningfully during this period.  It’s difficult to attribute recent weakness to any fundamental business reason, although earlier this year analysts cited cotton as a risk (cotton has since fallen significantly, and we discuss the cotton ‘issue’ below).  Instead, we believe the equity downdraft is mainly due to technical issues and Gildan having a high correlation to the S&P 500 Apparel, Accessories & Luxury Goods GICS Level 4 Index (S5APAC).  This index is down 33% YTD and represent mostly undifferentiated apparel names that suffer from headwinds we are all familiar with: demand weakness, cost inflation, supply chain woes, etc.  GIL is down similarly, but is sig less exposed to these factors due to vertical integration and lowest cost manufacturing ability.  GIL is being thrown out with the bathwater.

Quick company background: Gildan is the dominant supplier of blank (or undecorated) t-shirts which are sold to wholesale distributors in the imprintable channel.  Gildan’s products are ultimately decorated with designs and logos for sale to consumers by screen printers.  Imprintables are ~ 75% of their business today.  When Gildan went public in 1998 they had a 10% share within this category.  Although the company stopped disclosing share, we believe it is over 80% today.  The company achieved this through an unassailable cost advantage via manufacturing scale and vertical integration.  The company is one of the few players with start-to-finish manufacturing capabilities that include capital-intensive yarn spinning (all in the US) and labor intensive sewing facilities (all in ultra-low cost countries).  Gildan’s cost advantage is likely 15-20% below peers.  Gildan’s imprintable business generated 20-25% Op Inc margins historically (segment reported, ex G&A).

Here’s an overview of the imprintable market.  As one will note, pandemics are not friendly to the purchase occasions – think t-shirts offered at concerts, live events, company retreats, etc:

As Covid spread across the US in 2020, Gildan’s revenues got crushed, and distributors began to work down inventories at a faster rate than end-demand.  The reverse is occurring today.  Gildan claims inventory levels at the distributor level are still below pre-covid levels, and it’ll take until 2023 to get fully restocked.  The inventory bull-whip effect will provide nice support for top-line revenue through 2023.  Capacity expansion projects, mentioned below, will drive top-line beyond 2023.

The other 25% of the business is hosiery and underwear (and t-shirts) sold to retailers, such as Walmart (e.g., private label brand George), Target (e.g., under Signature Gold Toe banner), and Costco (Canada, Kirkland’s).  Although this business leverages the manufacturing scale and vertical integration of the company, hosiery and underwear is thought to be a 10% Op Inc business (vs +20% for imprintables).  The value proposition offered by Gildan is a focus on R&D that optimizes fit and comfort for a competitive price.  Gildan intends to grow this business by leveraging existing relationships with retailers (cross-selling), entering new international markets once new capacity comes online, and further penetrating the online channel (e.g. Amazon).  I suspect this business will feel a little bit of pressure from consumer weakness in coming quarters, but we believe the continued rebound in imprintables will more than offset any softness.

Historically the company has done 15% EBIT margins, but recent cost actions – known as their Back to Basics strategy -has increased this to 20%.  We believe this margin structure is the new structural level.  The key elements of Back to Basics Phase One are/were streamlining the corporate structure, consolidating distribution centers (currently undergoing), rationalizing capacity (exiting higher-cost manufacturing facilities in Mexico), and finally, simplifying the business through an aggressive 60% reduction in SKUs (eliminating underperforming brands and SKUs).  These actions helped reduced SG&A by 250 bps and improved GP% by a similar amount…that’s the high-level bridge from 15% to today’s 20% EBIT margins.

Back to Basics Phase Two is designed to leverage the streamlined cost base with accelerated top-line growth.  Gildan plans for significant capacity expansion in the coming years.  In the near term, the company plans to open capacity in Central America and the Caribbean (currently being ramped), as well as building a large-scale, vertically integrated manufacturing facility in Bangladesh (Kohinoor Phase 1, production ramp beginning Q1 2023).  These capacity additions represent $1bn in incremental revenues vs the current revenue base of ~ $3bn.  The company’s formal guidance is for 7-10% sales CAGR through 2024.  The higher end of the range gets you close to an incremental $1bn in revs (2024) off of 2021 levels. 

Putting it all together, we believe Gildan can produce $4.00 of EPS in 2024 vs street at $3.75.  This assumes $4bn in revs and a 20% EBIT margin.  The EPS output is not a large delta versus street but keep in mind GIL’s P/E multiple has compressed to almost all-time lows, so expectations are likely well below $3.75:

Using a reasonable 12x P/E on our 2024 EPS, upside is ~ $48, offering investors a solid 30% annualized return.  I keep the math high-level in order to avoid false precision around expected probabilities.  I think $4 EPS is reasonable assuming mgmt. hits their revenues and margin goals - this team has executed well in the past and I don’t have doubts they will continue to do so.  The inverse P/E is a good proxy of FCF to the equity, so you’re buying in at a 14% FCF yield (’24) at current prices.  In the meantime, management will continue paying dividends and shrink the share count by 5% per annum.  If we’re wrong, margins revert to the historical 15% and GIL does $2.50 - $3.00 EPS on a more tempered revenue growth outlook.  8 P/E x $2.50 = $20, (30%).  We view this as a solid 2:1 risk/reward situation.

Supporting the investment thesis are several tailwinds.  First is the secular trend of near-shoring.  That is, brands looking to meet their supply needs closer to home than in the Asian manufacturing hub.  Supply chain disruptions exacerbates this desire.  Private label, which Gildan supplies to retailers, continues to gain share within the apparel category.  Finally, inventory restocking within the imprintables channel act as nice support for the rest of this year and into 2032.  

A quick word on cotton, which is estimated to be 25% of COGS.  In the last year cotton’s price rise on the futures exchange from 80c/lb to 140c/lb created concerns around Gildan’s gross margins.  Initially, we attributed Gildan’s stock weakness on such concerns, as did other sell-side analysts, but our explanation proved to be misguided as cotton rapidly declined back to the 100c/lb level in recent weeks with no corresponding stock reaction.  Nonetheless, I think it’s important to consider the following dynamics.  First, Gildan employs a hedging program that in effect smooth’s out cotton’s price variability (company says they hedge one-year forward).  Higher hedging costs will get rolled through over the coming quarters, but Gildan is successfully implementing price increases to offset inflationary pressures.  In fact, price was a large contributor to Q1’s > +30% revenue growth (“price was a big part of our sales in Q1”).  The CEO used the word “broken” to describe the competitors’ cost structure at $1.20 cotton – everyone is getting hit so the industry is naturally raising prices.  During this inflationary period, Gildan’s value proposition is raising as competitors are forced to increase pricing more than Gil itself (their vertical integration mode, which encompasses the supply chain, provides a greater shock absorber from labor, freight, and raw mats than competitors).  

Two primary risks not discussed are the following.  First, GIL enjoys a msd tax rate since the sales and manufacturing operations are carried out in low tax rate jurisdictions in Central America and the Caribbean.  A 15% global minimum corporate rate presents a potential headwind, but implementation, if passed (unlikely), lands in the 3-5 year timeframe.  The second risk is what we refer to as a demand air pocket. This occurred several times in the last ten years when distributors reduced orders due to either lower end-demand or falling cotton prices.  The latter prompts distributors to work down inventories knowing they can buy cheaper product in the future once ASP’s reflect lower cotton.  We believe this risk is minimal as distributor inventories are already very lean and imprintable end-demand seems to be solid at the moment.

DISCLAIMER:  DO NOT RELY ON THE INFORMATION SET FORTH IN THIS WRITE-UP AS THE BASIS UPON WHICH YOU MAKE AN INVESTMENT DECISION - PLEASE DO YOUR OWN WORK.  THE AUTHOR AND HIS FAMILY, FRIENDS, EMPLOYER, AND/OR FUNDS IN WHICH HE IS INVESTED MAY HOLD POSITIONS IN AND/OR TRADE, FROM TIME TO TIME, ANY OF THE SECURITIES MENTIONED IN THIS WRITE-UP.  THIS WRITE-UP DOES NOT PURPORT TO BE COMPLETE ON THE TOPICS ADDRESSED, AND THE AUTHOR TAKES NO RESPONSIBILITY TO UPDATE THIS WRITE-UP IN THE FUTURE.  

Catalyst

Trading at 8x P/E, expectations are low for this long-term compounder (eg, Rev CAGR since '98 IPO +12%, EBITDA CAGR +15%, NI CAGR +17%); therefore, we believe management just needs to execute the expansion plans underway over the next few years in order to grow market share.  Other catalysts include near-term market share gains and accelerated buyback in 2022.