|Shares Out. (in M):||194||P/E||0||0|
|Market Cap (in $M):||7,890||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT||0||0|
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We recommend an investment in Gildan Activewear, Inc. (TSE: GIL & NYSE: GIL). GIL is a leading manufacturer of basic apparel. Gildan’s portfolio consists primarily of t-shirts, activewear, underwear, hosiery, and socks. The company was founded in 1984 by current CEO and Chairman Glenn Chamandy. Since founding the company, GIL has grown share from zero to >70% in basic t-shirts due to its operational focus and low-cost manufacturing model. We believe GIL is at an inflection point and will drive an accelerated topline algorithm due to: (i) a growing end market where GIL is the market share leader and low-cost manufacturer; (ii) a strong pricing environment; (iii) global supply chain constraints creating incremental demand for manufacturers like GIL who are vertically integrated; and (iv) increasing demand for ESG friendly partners. We hope these topics will be addressed at the upcoming investor day.
The P&L is split into two segments:
- Activewear which is comprised of t-shirts, fleece and sport shirts which collectively represent ~80% of revenue. This part of the business is primarily sold through wholesale distributors and serves the screenprinter / imprintables channel.
- Hosiery and Underwear is ~20% of sales and is sold through retail and mass. The volume is comprised of private brand programs such as Walmart’s private label underwear (George) and sock programs for large brands like Nike, Adidas and Under Armor.
Our thesis is predicated on the belief that the t-shirt industry is a commodity industry. Fundamentally, a t-shirt is a commodity product and is sold on price and availability. We believe GIL has both industry leading price and industry leading availability due to the execution of its ‘Back to Basics’ program. GIL announced their ‘Back to Basics’ strategy in 2018 but the strategy came to life during the COVID pandemic when GIL was able to accelerate its SKU count reduction. Since 2019, SKU count is down by ~60% from ~30k to ~12k today.
From the May 2021 annual meeting:
Ahead of the pandemic, GIL re-arranged its manufacturing footprint to prioritize high volume, high margin SKUs. The pandemic enabled them to swiftly cut SKUs and ultimately simplify the supply chain. GIL no longer offers small batch orders or low volume SKUs that complicated the manufacturing process, created logistical headaches, and carried a large sales force overhead. Moving forward, GIL’s portfolio is a structurally higher gross margin business with lower S&A overhead.
We think it is worth noting the benefits to supply chain simplicity that are not so obvious. The simplified supply chain has led to better inventory management at GIL. Our diligence indicate that the consistency of product availability has improved which is critical to their distribution partners. Additionally, the streamlined SKU count has improved the cost structure and enabled GIL to invest in price. During the pandemic, GIL lowered price in 2020 and improved margins in 2021. We believe these price-led share gains due to manufacturing efficiency will prove durable.
3Q20 Earnings Call:
‘Back to Basics’ has enabled management to achieve their target EBIT margin of 18%. Our diligence checks indicate the industry has seen margins expand at every level of the supply chain. We like the setup of an industry that is more rational and expect more rational pricing has structurally improved margins.
This playbook is exciting. Improved manufacturing + better inventory availability + lower price vs. peers = durable share gains. GIL has done an excellent job executing this playbook for its basic t-shirts and should be able to replicate the model as they move upstream to fashion t-shirts. Fashion t-shirts are exciting for GIL because they are the fastest growing segment of the market and carry a significant price premium. Today, we believe GIL has more than 25% share in fashion vs a majority share in basics. We see no reason why GIL cannot be a share gainer in fashion (see Exhibit D in Appendix for Fashion share). The primary competitors in fashion are Bella + Canvas and Next Level. We believe that the majority of fashion volume is through one SKU which plays to GIL’s manufacturing strengths and creates market share opportunity. GIL’s capacity expansion investments are geared toward the fashion segment which uses ring spun cotton vs. the basic t-shirt category which uses open end cotton.
Our bridge to an accelerating revenue growth story is fairly straightforward:
The TAM has grown throughout COVID. This is evidenced by the fact that volumes are back to 2019 levels despite live events and trade shows not fully returning in 2021 (see 3Q21 Transcript in Exhibit A in Appendix). Further reopening / normalized consumer mobility will drive incremental demand into 2022 and beyond. 2021 revenues in line with 2019 without the full return of live events and trade shows points to a growing end market driven by the online channel.
Pricing. We think this is misunderstood by investors and should lead to upward 2022 revenue revisions. Our view is that pricing is up significantly since the start of 2021 and the price increases are weighted in 4Q21/1Q22. GIL has maintained or expanded its pricing spreads as they have followed competitor led price increases.
One thing to remember about pricing: a $2.00 t-shirt moving to $2.50 at the wholesale level is immaterial to unit economics when t-shirts are sold for $20-40 at retail.
Further traction and share gains into fashion leads to positive mix.
Onshoring creates incremental volume demand for private label and branded programs. We see opportunity from Nike, Under Armor etc. who are actively looking to move manufacturing out of China.
It is our view that GIL is currently capacity constrained but will remedy the situation by executing on planned capacity expansion which has three parts.
1. ~$500m of capacity in Honduras. We are excited that the recent yarn manufacturer acquisition (Frontier Yarns, 12/13/21) accelerates capacity utilization. GIL has added the $500m of manufacturing capacity (see Exhibit A in Appendix) and subsequently secured additional yarn via Frontier Yarns. We expect quick utilization in 2022 of the new capacity.
2. ~$500m of capacity in new Bangladesh facility, ‘Phase 1’ (see Exhibit B in Appendix), that should be accretive to growth beginning in 2023. Bangladesh should prove to be a margin accretive operation that caters to the international market which is predominately fashion.
3. Incremental capacity in Bangladesh, deemed ‘Phase 2’. Per commentary from 2019’s Investor Day (see Exhibit B in Appendix), we see ‘Phase 2’ incremental capacity in line with ‘Phase 1’ incremental capacity of $500m. Given our view of capacity utilization ramp in ‘Phase 1’, we think ‘Phase 2’ expansion happens quickly after ‘Phase 1’ is complete.
While all of these projects together may seem large relative to GIL’s 2019 revenue base, we believe each announced expansion could be filled with one large retail or private label program. Onshoring and GIL’s advantage of being vertically integrated should be fruitful over the coming years.
It is worth noting that GIL’s recent acquisition of Frontier Yarns should de-risk the capacity additions. As the Company has indicated, yarn supply has been tight and has limited GIL’s production. Frontier will add significant yarn supply to GIL and increases the mix of internally sourced yarn from ~65% to >90% (see Exhibit C in Appendix for further detail). The most important part in our view is that Frontier produces yarn that is utilized in fashion and fleece which are the two highest growth and highest margin products. There has been a little bit of confusion by the street on the economic terms but we view the transaction as immediately accretive to GM and EPS.
To frame the capacity expansion:
2019 Revenue: ~$3b
~$500m Honduras expansion
~$500m Bangladesh ‘Phase 1’ expansion
Bangladesh ‘Phase 2’ expansion, incremental capacity in line with ‘Phase 1’
Total = ~$4.5b of total revenue
Assuming 18% EBIT margin on a run-rate basis (in-line with company guidance, which we view is conservative), we think the outlined capacity expansion results in an EPS number above ~$4 per share without any pricing. This compares to current 2022 consensus $2.70/shr. Valuation today is undemanding at ~15x 2022 Consensus EPS. We see a path to both fundamental earnings upside and multiple expansion as GIL improves its revenue growth rate. The business has structurally improved on the other side of the pandemic. This has been driven by cost discipline and a ~60% reduction in the SKU count which has resulted in EBIT margins improving from ~14% in 2019 to ~19% in 2021 based on consensus. We are excited to see GIL execute on its capacity expansions and drive accelerating revenue growth through its new and improved cost structure.
We think there is adequate conservatism in management’s 18% EBIT margin target. We believe management’s 18% target allows for a utilization ramp of upcoming capacity additions. The ~$500m of capacity in Honduras feels particularly conservative as the infrastructure is already in place and the capacity is simply adding additional machines that the company already owns. In Bangladesh, we believe the low-cost labor market and a higher mix of fashion will ultimately be accretive to company margins. Additionally, since the 18% EBIT margin was announced, the pricing environment has improved and the acquisition of Frontier Yarns should be a structural lift to margins.
Capital allocation playbook:
Buyback program – GIL has communicated they intend to buy back 5% of their shares on an annual basis. We see upside to this number. Current leverage as of 3Q21 is 0.4x vs. target of 1-2x. Even after Frontier Yarn acquisition, leverage is ~0.7x (see Exhibit C in Appendix).
Dividend – we expect annual dividend growth of 15%, in line with 2021.
M&A could come in two forms, we would view both positively.
Capacity expansion or incremental yarn capacity.
Upcoming Investor Day –
Expect to highlight revenue growth opportunity.
ESG message - emphasis on GIL’s manufacturing process and facilities. We view the ESG message as impressive and encourage you to look at GIL’s biomass.
Positive 2022 Revenue estimate revisions.
COVID and live event exposure.
Cotton inflation. We believe the recent run-up in cotton prices has been addressed with incremental pricing. At ~25-30% of COGS, we believe a 10% increase cotton can be offset by a LSD price increase without any other efficiencies. See Exhibit E in Appendix for COGS breakdown. Additionally, GIL has historically hedged their cotton needs ~3 quarters out.
Manufacturing concentration in Honduras – prone to hurricanes.
Exhibit A – Commentary regarding additional capacity in Honduras:
3Q21 Earnings Transcript:
Exhibit B – Commentary regarding Bangladesh capacity expansions to support fashion basics and private label programs across Europe:
3Q19 Earnings Transcript: