Description

Investment thesis:

-        Hanes is a good business that has been undermanaged for the past decade. 

-        New CEO Steve Bratspies is making all the right moves to return HBI to consistent organic growth.

-        The market is slow to recognize the inflection in the business due to significant investor fatigue. 

-        Portfolio of healthy 100+ year old brands provides a strong moat. 

-        Concerns about consumer spending and inflationary pressures have provided a great entry point.  I estimate HBI is trading at ~6x normalized earnings.

Company description:

-        Vertically integrated manufacturer of branded apparel. 

-        Primarily a wholesale business. 

-        Walmart (17% of sales) is only 10%+ customer. 

-        Other large customers include Target, Costco, Kohls, Amazon, Dicks Sporting Goods, Dollar General, Macys, Nordstrom, Foot Locker, and Urban Outfitters.

-        Produce ~70% of units in house. 

-        Own and operate chain of 245 outlet stores in U.S.  Also own and operate retail stores throughout Australia and Japan.

-        61,000 employees.  Manufacturing hubs in El Salvador, Honduras, Dominican Republic, and Vietnam. 

Key brands:

Hanes (~43% of sales) 

-        Leader in basics

-        Number one selling apparel brand in U.S. by unit volume

-        Worn in 9 out of 10 households

-        Founded in 1900

Champion (~33% of sales)

-        Sweatshirts, sweatpants, sports bras and other athleticwear

-        19% 5-year sales CAGR

-        Founded in 1919

Bonds:  (~8% of sales)

-        Number one basics brand in Australia

-        Founded in 1915

Women’s innerwear (~12% of sales):

-        #2 in U.S. in bras, panties, shapewear

-        U.S. brands include

o   Maidenform.  Founded in 1922.  #1 in shapewear.

o   Bali.  Founded in 1927.  #1 dept store bra.

o   Playtex.   Founded in 1947.  Plus size wireless bras.

-        Australia brands include Bras N Things, Berlei, Lovable

Overview: 

I believe the market has largely ignored the fundamental improvements taking place at Hanesbrands.  In August 2020, Hanes hired Steve Bratspies, who was previously the Chief Marketing Officer at Walmart.  He has led a strategic and cultural shift that was badly needed and is already showing signs of paying off. 

Under the prior CEO/COO, Gerald Evans, Hanes neglected its core innerwear business by underinvesting in marketing and innovation.  Instead, management focused on an international rollup strategy.  This left Hanes vulnerable to market share losses in women’s intimates and destocking as secular declines accelerated in the department store channel.  Moreover, management was caught in a vicious cycle of cutting advertising and other variable expenses to meet EPS targets. 

This backdrop led to persistent LSD% organic declines in innerwear sales.  Earnings quality deteriorated as “one-time” items proliferated.  Debt balances and leverage ratios increased yet EPS remained stagnant.  Then the pandemic hit.  While retailers destocked, Hanes pivoted to making cloth masks.  However, the company spectacularly over-produced which caused a $400mm inventory write off.  The board finally replaced Evans with Bratspies.

When Bratspies joined, he immediately recognized that the business was suffering from chronic underinvestment and unnecessary complexity.  I would describe his approach as “back to the basics.”

Actions:

-        Replaced most of the c-suite including a new CFO that was previously CFO of Walmart U.S. 

-        Exited the mask business. 

-        Sold money losing European business. 

-        Simplified the supply chain (cut 30% of SKUs). 

-        Invested in inventory for the remaining SKUs to minimize stock outs. 

-        Significantly increased marketing spend (+$95mm YOY).

-        Prioritized investments in technology, data and analytics. 

-        Flattened organizational structure to increase speed of decision making.

-       Put the sheer hosiery business up for sale (TBD).

Early results are promising.  HBI has already gained ~150bps of innerwear market share since ’19.  Sales are comping well above 2019 levels.  Champion sales continue to grow at a double-digit pace.  Women’s wear has expanded distribution.  Anecdotally, employees are energized by the growth-oriented mindset that Bratspies is pushing.  I’ve also been told he has brought a culture of accountability that was badly needed. 

The resilience of underwear:

Underwear is a heavily branded category.  Historically, private label penetration has remained low (~10%) over time.  This is because it is a low-ticket item that is worn against the skin all day, every day.  Once a consumer settles on a favored brand of underwear, he or she is likely to remain loyal to that brand in the future.  Most people don’t want to risk sacrificing comfort for ~$.50 a pair.  This is particularly true as sales move online where the propensity to try private label decreases across almost all categories.  These dynamics have allowed for pricing power and stable margins over time.

Gildan case study

Gildan’s failed attempt to meaningfully scale a branded innerwear business is a good proof point that Hanes has a moat.  In the early 2010s, Gildan began making a push into the branded space.  The company acquired several sock brands and won a big underwear contract in 2013 to replace Walmart’s private label brand (called Faded Glory, manufactured by Gildan and two others) with the Gildan brand.  The company created a new reported segment and held numerous investor meetings highlighting the huge opportunity to take share from sleepy incumbents.  However, despite a massive push from the organization, the results were mixed at best.  In 4Q’17, Walmart decided to remove Gildan branded underwear and return to its previous private label strategy.  In response, Gildan announced a new organizational structure.  The U.S.-based branded employees and initiatives were either terminated or absorbed by the Barbados-based Printwear segment.  Gildan quit reporting its branded sales.

The strength of Hanes

Despite underinvesting in marketing over the past decade, Hanes has remained a very healthy brand.  Hanes is significantly larger than its next largest competitor Fruit of the Loom which itself is meaningfully larger than Jockey, the third largest player.  This scale allows Hanes to earn structurally higher margins by spreading its marketing and R&D costs over more units.  This scale is demonstrated by Hanes’ 30-year endorsement partnership with Michael Jordan. 

Given the significant increase in marketing resources, I expect HBI to gain share in the coming years.  Fruit of the Loom, owned by Berkshire Hathaway, is run for cash and has been gradually losing market share in most categories since the early 2000s.  I expect this to continue.  In addition, Walmart has recently increased shelf space to Hanes (the have-to-have brand) and its own exclusive private label brand at the expense of smaller mid-tier brands like Jockey.

    Source:  Euromonitor

The resurgence of Champion:

Champion’s storied history began in 1919 when the Feinbloom family started a sportswear business in Rochester, NY.  Champion’s popularity grew in the 1920s and 1930s as it became known for its collegiate apparel including the now ubiquitous hooded sweatshirt (which Champion appears to have invented).  Over time, Champion grew its business beyond college athletics by introducing physical education uniforms, mesh jerseys, and sports bras.  Champion’s popularity peaked in the late 80s and early 90s when its logo was on the uniforms of numerous professional and college sports teams including every NBA and USA Basketball jersey. 

In 1989, Sara Lee, a large food-focused conglomerate, acquired Champion.  Sara Lee initially invested in expanding Champion, but by the 2000s it had become a small cog in a larger machine.  The brand was neglected and starved of resources and over the next decade and its popularity faded. 

In late 2016 Hanesbrands re-acquired the global rights to Champion (which Sara Lee had divested) and began to develop a strategy to rejuvenate the brand.  The former president of Activewear, John Marsh, focused his resources on getting Instagram influencers to wear and promote Champion products.  This strategy was highly successful and led to a virtuous cycle of celebrity endorsements and increased distribution.   Champion also found success partnering with a half dozen hip streetwear brands including Supreme.

When Champion’s resurgence began in the middle of last decade, it was hard to know if it was a fashion-oriented flash in the pan driven by 90s nostalgia or if it was the beginning of a more durable growth trend.  With time, it increasingly appears to be the latter. 

Champion is well positioned to continue benefiting from the athleisure megatrend that has propelled brands like Lululemon and Athleta to huge popularity.  As a result, department stores like Kohls continue to increase shelf space to athleisure brands at the expense of fashion focused brands.  “The Kohl’s store and brand is going to look and feel different.  Active and casual are going to be at the center of that.”  - Kohl’s CEO Michelle Glass.  It is also telling that she considers Champion a core brand.  “We have great partnerships with the ‘big four’ in activewear (Nike, Under Armour, Adidas and Champion).”  

Champion has particularly resonated with Gen Z, a group that highly values authenticity.  Moreover, youth cultures around the world are increasingly adopting the stereotypical collegiate look which plays directly into Champion’s strengths. 

This momentum gave management the confidence to announce at its investor day in May 2021 that Champion would grow to a $3b global brand by 2024, a 14% CAGR.  Management has since revised that target higher, to $3.2b, due to a strong innovation pipeline, new doors, increased shelf space, and additional geographies. 

Channel headwind is leveling out

Over the past decade, Hanes has seen persistent pressure from department store door closures.  This had the greatest impact on HBI’s women’s brands which have lower market share in other channels.  While this will continue to be a drag for HBI as more department stores close, on the plus side, the channel has become less important to HBI (~7% of normalized sales).  I will note that department store sales were a little funky in both 2020 and 2021 due to several distortions (PP&E sales in ’20, Europe divestment in ’21, non-essential biz shutdowns in ’20, re-stocking in ’21). 

Compelling valuation:

Despite all the positive changes going on at Hanes, the stock is trading on the low end of its historical absolute and relative multiple ranges. 

EV/EBITDA:

P/E:

Relative P/E to S&P 500:

Relative metrics to peers:

Valuation summary:

This year HBI’s earnings are depressed by inflation / supply chain challenges.  Adj. EPS is expected to come in on the low end of prior adj. EPS guidance of $1.64-1.81/shr. 

In a more typical year, I think HBI will earn $1.94/shr. 

Here are my assumptions:

Therefore, I think HBI is trading at ~6x normalized P/E and ~10x normalized NOPAT.  This compares with the 10-year historical P/E of 12.4x forward earnings.  If I’m right that HBI will return to growth in innerwear in 2023 and beyond, I expect the company to rerate to 10x EPS at a minimum.  Frankly, I think 12x is more appropriate. 

Moreover, I thought it was telling that on a recent earnings call (2/3/22) management increased its 2024 guidance to $8,000 of revenue and 14.4% adj. EBIT margins.  This was not necessary since they had already put out 2024 targets of $7,400 and 14.3% adj. EBIT margins at their investor day roughly nine months prior.  Management also initiated a $600mm repurchase program they plan to exhaust over the next three years.  This is in addition to a $.15/shr quarterly dividend (~5%).  If they hit their updated guidance, they could earn ~$2.40/shr in 2024.  Even if they fall short, it is not hard to envision a scenario where the stock is a double in 2-3 years.  As a positive sign, Bratspies and a director bought stock at ~$15/shr in February.  At this price I think HBI is takeout bait for a serial acquirer like VF Corp or private equity. 

Key risks:

-        Champion loses its luster:

o   Less than a decade ago, Champion was out of style.  However, Champion a) was previously popular for a very long time and b) is best known for items that typically have below average fashion risk (sweatshirts, sweatpants).  Given increased marketing and distribution, I think there is a good chance Champion continues to grow.  However, to be conservative, I model HBI’s 2024 sales at ~$500mm below the recent guidance. 

-        Market share losses in basics:

o   HBI could lose share to either private label or new entrants.  This is currently happening in women’s intimates (to Aerie, owned by American Eagle) which I expect to continue.  On the men’s side, history has shown that a) men’s basics is a brand loyal category and b) private label penetration has been modest over time. 

-        Aggressive innerwear guidance:

o   HBI benefited in 2021 from significant restocking which led to sales above pre-pandemic levels.  However, management recently guided the innerwear segment revenue to flat-to-down-2% (vs. my previous expectation of at least mid-single-digit declines). 

-        Persistent inflation:

o   HBI margins will be below normal in 1H’22 due to increased freight, raw materials (incl. cotton which is ~10% of COGS), and labor costs.  If inflation remains higher for longer, it will take longer for HBI to return to normal margins. 

-        Tax issues:

o   HBI has historically benefited from complex corporate transfer pricing that allows HBI to earn profits in jurisdictions with lower tax rates.   To help mitigate this risk, I assume HBI’s tax benefit moderates (I use a 17.5% rate going forward instead of historic rates of 10-12%). 

-        Cyberattacks:  HBI recently disclosed a ransomware attack. 

Catalyst

cash flow