Description

Description: GIL is a leading manufacturer of Activewear & Printwear  (80% of revenues) as well as socks and underwear (20%).  Printwear is a $6.5B market -- a third consists of basic apparel where GIL has 80% share, a third is fashion basics where GIL has 20% share and nearly 30% is in uniforms /other where GIL does not participate. Printwear generates 24% operating margins due to GIL being vertical integrated/lowest cost producer and dominant market share (scale). Branded apparel margins (mostly socks/underwear) are about 9% as a result of socks being a commodity with more competition. Over 90% of sales are in North America with AlphaBroder being the largest customer at 16.5% of sales and Wal-Mart the second largest at 12%. GIL competes with Hanes and Fruit of the Loom in basics, socks and underwear; Bella+Canvas and NextLevel in fashion basics.

Thesis: The secular shift to private label apparel is in early stages and GIL is best positioned to benefit from this trend given its lack of branded apparel exposure and status as lowest cost producer. I believe significant program wins at Wal-Mart and Target are coming in the near term. Fashion basics is growing at a double digit rate and GIL has "only" 20% share of this category - I believe they can double their share over the next few years due to recent platform purchases of American Apparel, Anvil, Alstyle and Comfort Colors. I believe EPS growth will be 20% per year over next few years and consensus estimates are materially below mine. Potentially $3 in FCF/share by 2020 with net/debt EBTIDA at 1.2x.

Private Label Apparel: Mass retailers have already made a sizable shift to private label food and the pivot to private label apparel is still in its infancy. Wal-Mart, Target, Amazon and others have publicly expressed their desire to shift to private label to lower prices and obtain better margins in an environment where consumer are less brand loyal.

Dollar General: "continue to see opportunity around private label and foreign sourcing"; "opportunities to increase our private label penetration"

Dollar Tree: "the important elements that will change the sales trajectory...more private brand offerings"; "big focus on private label"

Wal-Mart: "we have really stepped up our focus on private brands"; "there are numerous opportunities for us to build private brands"

Costco: "it's about 24% of our sales....will it increase? Yes."

Target: "I think the usage of private label...is huge, particularly now, that they are really striking on the iron hot here. Store brand stigma is a fraction of what it used to be"

Amazon's private label sales in Electronics is 55% of the category total and represents 41% of their CPG sales yet just 1% of Apparel. Amazon Basics did just $210M in sales in the 1H of 2017 which compares to $20.3B of gross merchandise value sold on Amazon. Overall, private label apparel and shoe sales saw a 5.4% CAGR between 2011-2016 according to Euromonitor. However, GIL is just starting to focus on this category and is well positioned to take considerable share. GIL is the lowest cost producer as they buy raw cotton, spin yarn, manufacture and stitch. They are one of the largest buyers of cotton in the United States. According to industry contacts I've spoken with, GIL has the best and most modern equipment and "likely" has at least a 500 bps gross margin advantage. It is important to understand GIL's starting point in entering private label vs. its large peers. About 90% of GIL's activewear/printwear business is wholesale with maybe 10% being branded retail apparel (which actually relates to its relationship with Nike and Adidas for manufacturing). This is in stark contract to Hanes who generates the bulk of its revenue through branded retail apparel (Champion brand, for example) and enjoys higher gross margins despite being a higher cost producer. This puts GIL in a substantial position of strength to capture this opportunity as its accretive for them vs dilutive to Hanes. The private label opportunity is significant within underwear as well. Gildan has a 12% market share in underwear (virtually zero several years ago) and has about 10 ft of shelf space within Wal-Mart vs 40 ft for Hanes and Fruit of the Loom. GIL just recently announced a private label underwear program with WMT which could add 50% to its shelf-space. Although bears will argue that the private label mix shift is a headwind to margins since the private label product replaced GIL's branded udnerwear business, I believe this analysis is flawed. GIL's private label product will actually come at a HIGHER price point than the GIL branded underwear. It will be a high quality offering and not a value offering. Likewise, I belive that the gross margins will be comparable (perhaps slightly lower) but GIL will eliminate significant SG&A such that the operating margin impact will be ACCRETIVE. Note that GIL's SG&A is declining on a dollar basis and they guided for flattish SG&A next year despite accelerating revenue growth. The WMT private label win coupled with another significant udnerwear program launchign at a large club store chain could lead to 50% growth in Underwear sales for GIL in 2019 - this alone would contribute 250 bps to revenue growth overall.

HBI recently announced it is terminating its relationship with Target for the C4 brand as the latter intends to switch to private label fleece. GIL is very well-positioned to capture this business. I believe the addressable market for GIL in private label for mass retaielrs is about $4.5B, a sizable opportunity relative to its existing TAM in printwear of $6.5B

Fashion Basics: Within printwear, fashion basics is a $2B category growing double digits. The category is witnessing very strong growth due to the trends towards casualwear within the work environment and the proliferation of online low-run printers (CustomInk, Vistaprint) that enables consumers to produce small run custom apparel. While GIL has 80% share of the low growth "basics" category, it has only 20% share of fashion basics. The company has aggressively focused on this category with the acquisitions of American Apparel, Anvil, Comfort Colors and Alstyle. According to industry participants that I've spoken with, Gildan's cost advantage vs peers is even more drastic within fashion basics. Bella+Canvas and next Level are the largest competitors and do not spin their own yard nor do they have the scale and distribution network of GIL. I estimate that Bella+Canvas and NextLevel combined to only $700M of sales annually (although growing fast). One large customer I spoke with expects GIL to take share within their portfolio given the quality, price and large portfolio of SKUs.  The gross margins of fashion basics are considerably higher than traditional basics. Whereas the average basic tee wholesales for $1.50 with 30% gross margin, the average fashion basic tee wholesales for $1-$2 more with only $.25 of incremental cost. This suggests the gross margin on fashion basics is perhaps more than double that of basic tees. Likewise, the mix shift is a positive tailwind for margins.

Over $800M worth of capacity coming online: GIL has invested significant amounts in capex, in part, to dramatically increase its capacity to position the company for growth in fashion basics and private label. Although the company has been relatively silent on how exactly the capex will get filled, multiple sources have said that GIL is the best in the business and would not add capacity on spec. They invest on what they see and not on what they hope. Given they recently raised guidance - which implies high single digit revenue growth in Activewear for the balance of the year - I believe we will see revenue acceleration into '19 as the increased capacity comes online and the capacity constraints they currently have abate. Importantly, the capex associated with the buildout is complete so the impact on free cash flow will be material. Management has said explicitly that new business will be at margins comparable to Printwear (25% operating margins). Assuming 22% margins and some cannibalization of new capacity, I believe the investment could generate an incremental $.56/share in EPS or 30% accretion.

Branded Sock Program Loss Irrelevant: GIL's sock business (20% of 2017 sales) will likely be down about 16% this year due to the loss of the Gold Toe branded sock program at Wal-Mart. This was a low margin business as GIL outsourced production. Importantly, the financial impact is immaterial. The removal of this program will enable GIL to cut SG&A while accelerating the topline growth overall which will elad to significant margin expansion in 2019. Mgmt has stated that they think branded apparel margins should approach that of their Printwear business.

Int'l Opportunity: GIL generates only 10% of its sales internationally yet has infrastructure and distribution capabilities in Asia. GIL is now growing international revenues 25% and this should continue particularly via fashion basics where American Apparel has strong brand recognition. American Apparel has a better brand in many parts of Asia than in the United States. 25% growth on 10% of the business is 250 bps of topline growth alone.

Guidance / Consensus Too Low - $3+/share in FCF in '20: GIL has targeted 1x-2x debt/EBITDA and is operating at the low end of that range currently. If my assumptions are right for both revenue acceleration, margin improvement AND lower capex, the share repurchase potential is substantial. GIL can easily repurchase 8% per year of shares outstanding and still maintain 1.2x debt/EBITDA. This year the company has guided to buying 10% of shares outstanding.  GIL has guided to LT aspirations of MSD sales growth and HSD-LDD EPS growth. Consensus has modeled accordingly. I believe GIL can generate HSD sales growth and DD EPS growth over the next few years on the heels of private label program wins, fashion basics share gains and International growth, offset by a 5% decline per year in socks. My estimates for 2019 and 2020 are 10% and 20% ahead of  the Street for EPS and I believe GIL can achieve $3/share in FCF in 2020 which equates to a 10% yield.

Valuation: Using 15x FCF/share in 2020 equates to $45 stock or 50% upside. In a bull case scenario, a consumer staple with HSD topline growth and oligopolistic position in end markets could generate a substantially higher multiple.

Risks: GIL manufactures much of its product in Honduras and, to a lesser extent, Nicaragua and Dominican Republic. Social and political unrest are risks -- in Honduras last year ,Q4 results were negatively impacted by about 97 bps due to disruptions from the elections. Nicaragua had some minor impact earlier this year ($.02 in Q2) and while they don't expect much of an impact moving forward, the risks are there.  Another risk is continued weakness in socks which is now sub-$500M business. I model a 5% decline although company believes it should show vey modest growth. GIL operates out of the Barbados and due to a treaty between Canada and Barbados, GIL enjoys a very low 4% tax rate. Cotton prices can be volatile and any sudden significant moves would impact financial results in the short term. There was a massive spike in cotton in late-2011 (up over 100%) which caused GIL margins in the short term to contract about 500 bps in 2012 vs 2011.

Catalyst

I believe we could see some press releases out of GIL pertaining to new private label tees, fleece and/or underwear programs which should act as a catalyst. I believe operating margins will exceed consensus over the next few quarters which will debunk the bear case of private label margin compression. Concurrent with the margin expansion we will see revenue acceleration -- note in Q3 sales would've been up nearly 10% (WELL ahead of consensus) if not for the storm impact in the Carolinas.