Description

Business Description:

Gildan is a leading vertically integrated manufacturer of basic apparel, including activewear, underwear and hosiery.  The company was founded by Glenn Chamandy (remains CEO and owns >$100m of stock) and his brother Greg in 1984 and is headquartered in Montreal, Canada.

Gildan is the global leader in wholesale blank activewear apparel.  Blank activewear is apparel that is bought in bulk at wholesale, and then printed on and either given away or sold at retail.  Examples of end markets / customers are corporations (“corporate swag”), sporting events, tourism, concerts, academia, etc.  Gildan also wholesales white-label socks and underwear (for example, they make all of Wal-Mart’s white-label underwear).

Gildan believes that its addressable market is $22b, approximately 5% of the global apparel market.  The market is split roughly 75% activewear and 25% hosiery and underwear.  By product within activewear the market is roughly 60/40 t-shirts / fleece – t-shirts are split 50/50 open-end (basic) / ring-spun (fashion), with basic growing LSD, fashion growing MSD and fleece growing M-HSD.  By geography the market is split roughly 80% North America and 20% International.

Gildan has to main channels: distributors and retailers.  Distribution is the majority of the business – the three largest are SanMar, AlphaBroeder and S&S Activewear.  Gildan sells to these distributors who in turn sell mainly to screen printers / designers who are selling to corporations (corporate swag), entertainment / tourism, schools and sports teams, etc.  The rest of the business is selling wholesale to retailers from Nike to Wal-Mart – this channel includes Gildan’s hosiery and underwear business.

As the only vertically-integrated blank apparel manufacturer, the company has facilities that span operations from yarn-spinning through textile production, cutting & sewing and distribution.  The geographic location of the company’s facilities have been mainly yarn-spinning facilities in the southeastern U.S. (strategically located to both lower transport and logistics cost, as well to qualify for NAFTA rules of origin), and textile, cutting & sewing facilities in Central America (mainly Honduras).  The company has had a small presence in Bangladesh, which it is expanding significantly to bring on more ring-spun / fashion activewear capacity.

Thesis Summary:

Gildan is a high quality, sustainably competitively advantaged business.  Despite selling a commodity product in a competitive industry, Gildan is one of the most profitable major apparel companies in the world, with operating margins in the 18-20% range (vs Nike, Ralph Lauren, VF Corp, Under Armour, etc. in the 8-12% range), and >20% RONA.  I gave a brief overview of the company’s assets in the description that hopefully gave a sense of the vertical integration, but it’s also worth stressing that the company’s assets / cost structures have been developed and built in a very thoughtful way in order to make them both durable and environmentally friendly.  Between Gildan’s scale and vertical integration, they are consistently able to offer product at ~70% of the cost of the competition, while earning significantly higher margins; as the former COO of Next Level Apparel (one of their main competitors in the ring-spun / fashion market) put it, “Gildan, because of the way they’re structured, they will always, always be the lowest-cost producer”.  I have pasted two quotes below from a former Gildan employee who also spent a significant amount of their career at Hanes.  I apologize for the length of the quotes, but I think they give some great detail on Gildan’s vertically integrated operations and cost structures, versus those of a non-vertically integrated competitor.

“So manufacturing excellence is about engineered efficiencies and cost structures. For example, when you're making your own product, Gildan buys their fiber, but then they spin it, they have open-end spinning, they have ring spinning. They have air jet spinning. And then they have the advantage in Honduras, and they have their own chemistry building that pipes all the chemistry.  So when they're buying chemicals, they're not buying water, they're buying raw materials and making the chemicals themselves. A huge competitive advantage. Farmers bring them their local vegetation after the crops have been harvested and they burn that and other agricultural products to generate their own energy, their own steam power, their water filtration system is powerless. It's called Biotop.  You can find the information on that also on the Internet. But Biotop is a series of ponds. It's that feed one into another by gravity with vegetation patches in between the filter, the chemicals as it transitions from the highest level pond down to the river. And the water is cleaner going into the river than it came out and it's zero energy to clean all that water. It's just amazing. So their cost of energy are pretty low, and that Honduras is not the cheapest on energy.  But Gildan has a big advantage with that. So they're really green there. And then their manufacturing model, they'll set up their process so that they take advantage of the same machine so they can set up the same machines the same way without variability. So it's reducing manufacturing variability by high-volume sameness of machines and then high level attention to maintaining those machines. So their machines that they use in yarn spinning all the way through are maintained at a high level and they're run at very high speeds. So they run them at the highest speeds possible by their maintenance schedules and they're so good at it because they have the same thing. If you go into a Hanes factory, textile mill, you'll find a hodgepodge and most textile factories I've been in and you'll find so many different machines because there's so many different dye machine and finishing machine manufacturers and they all get in with deals or whatever.  And all these textile companies buy these different machines which have different settings require different maintenance schedules and they introduce different types of variation. So what Gildan is really, really good at is minimizing variation driven by equipment and they run very efficiently by running them at the high speeds possible while not impacting the condition of the machine, it's brilliant. The way they go about it is actually brilliant. And in my opinion, they're really not touchable.  I mean the investment they have, they're not high-risk proposition. I mean being in Honduras might be the highest risk, but they've got such a culture of loyalty in the community. They're very engaged with the local politicians. They are very engaged with the local schools and community services. They provide food and shelter and educational opportunities. They help their employees by paying for a large portion of the food that they have whether at work. So they're really good to their people and the people are pretty darn loyal actually, relatively speaking, low turnover, extraordinarily low management turnover and pretty low employee turnover for that country.  So they're just high volume, low cost of raw materials, low cost of energy, high efficiencies and then they're really good at designing products to take advantage of material usage, their material utilization schemes are world-class. Their pattern-making the way they use tubular goods whenever possible to avoid side seaming that decreases the pounds of fabric per dozen produced.”

• Former VP Global Quality Management at Gildan

“So Hanes, early on when I worked at Hanes, we were a vertical, we owned our own yard mills, textile mills, cut and sew mills, very similar, but then Hanes started spinning off. They got some consultants in and at one point, they were going to go all marketing and then they landed at a mix. They spun off the yarn mills and the textile mills and they brought the textile mills back. Right now, their model is that. They've got some owned textile mills.  They don't own any yarn. The biggest disadvantage, in my opinion for a commodity-based high-volume manufacturer is that yarn proposition because Hanes lost at a competitive advantage when they spun off the yarn. And so those are my general thoughts. I'm familiar with the trade-offs of all the quality along the way……  They spun off from Sara Lee in 2006. And just in that whole time leading up to that spin-off, they were trying to go brand. And because Nike went brand.  Nike makes nothing themselves. Now the secret sauce of Nike is not the manufacturing excellence. The secret sauce of Nike is the value of the brand.  In my estimation, the value proposition is quality divided by price times the brand factor. Margins at Nike are north of 50%. The shoes are insanely profitable, and the apparel was insanely profitable in my opinion. And in fact, I mean, the quality of the garments was not superior to these other brands.  In fact, in some cases, inferior because they were trying to save money on the fabric and put the swoosh on it and people go buy that swoosh anyway, which was unbelievable to me, but it did teach me the power of the brand and the brand messaging. And so Hanes has tried to build the brand, but Hanes is commodity-based. Hanes is in Walmart and Target, Kmart, Sears.…..  They have too much debt.  Gildan, relatively speaking, has no debt. You can see the income statements the stockholder releases. They don't have a lot of debt. Hanes has more debt than the company's worth. You buy Hanes stock; you're taking a risk of losing everything at some point. There's a ton of value in Gildan, tons of value.”

• Former VP Global Quality Management at Gildan

Gildan has continued to increase their competitive advantages.  For example, in 2021 they acquired the other (second largest after themselves) major MVS yarn (used in fleece) producer in the U.S., which a VP at distributor Sun Apparel called a “phenomenal strategic move”.  To give you a sense of Gildan’s scale and vertical integration, they consume 40-45% of U.S.-produced cotton.

Gildan’s business has been impacted by several discrete events over the past three years that have given investors the sense that the business is ex-growth.  To simplify, the order of events has been something like this.

• Pre-COVID the company had launched their “Back-To-Basics” strategy, which while very positive for the company’s returns and prospects for future growth, had a near-term negative impact on growth as they rationalized certain parts of their product portfolio.
  • Necessitating the “Back-To-Basics” strategy, Gildan had previously gone through a period where via acquisition they added to much brand / product / distribution complexity to the business.
• COVID hit and industry demand temporarily plummeted, as it did in many industries across the world.
• During COVID, in 2020, Honduras (where Gildan has the bulk of its existing textile, cutting and sewing operations) was hit by not one, but two hurricanes.
• As demand bounced back, Gildan actually found themselves at a very unique and temporary disadvantage; COVID stimulus / behavior made staffing their southeastern U.S. yarn spinning facilities very difficult, and they fell behind their competitors in inventory availability (one of the most important factors for demand – Glenn describes the company as a “capacity-led sales organization”).
• As Gildan’s yarn spinning staffing and inventory finally improved, post-COVID demand was already waning as a result of supply chain bull-whip effect / inventory rationalization.

As a result, initially as a result of their “Back to Basics” plan, and then compounded by some successive but unique factors, Gildan has shown anemic growth over the last ~5 years.

Gildan’s market is already “bumping along the bottom”, despite broader recession concerns.  Our understanding of Gildan’s main end markets (via distribution) are ~25% corporate / promotional (“corporate swag”), ~20% brick & mortar and online retailers, ~15% events / tourism, ~15% sports, ~10% schools / collegiate, and the rest “other”.  While events / tourism, sports, schools, etc. has come back strongly, our understanding is that corporate started to come back and then was almost immediately stunted by tech carnage / layoffs and recession fears, while the retail segment has been pressured as retail inventories been realigned.  While there remains broader concern about an impending recession, we believe that Gildan is already living through one.  A few supporting quotes from large industry participants below:

“So right now, the market is really bad for blank industry right now….. It's all destocking and trying to brace for a possible recession”

• Former COO of Next Level Apparel

“I would say our industry in general, this is probably the hardest we've been hit in the last 10, 20 years. We've always kind of considered ourselves recession-proof in a sense. And I think this has been the longest that anyone has seen a softening without it technically being a true recession”

• Sr. Director of Marketing at S&S Activewear

Gildan is poised to accelerate growth and share gains in the ring-spun / fashion segment of the market, similar to its historical performance in the open-end / basic segment of the market.  For context, in the 90s, Fruit of The Loom and Hanes had ~70% of the open-end / basic market.  Today, Gildan (they used to report / talk about market share but no longer do – this behavior can be, as cuyler1903 has pointed out and as noted in Peter Thiel’s Zero to One, a confirmation of very high market share – i.e. monopolists lie / obfuscate) has ~80% share of that market and is widely regarded by industry participants as impossible to compete with.  Gildan’s market share ascent culminated with their effectively driving Anvil out of business during / post the GFC and acquiring them for <~100m.  Today, Gildan sits with 30-40% of the ring-spun / fashion, with the bulk rest of the market being nearly evenly split between Bella + Canvas and Next Level.  Both Bella + Canvas and Next Level are already struggling in the ring-spun / fashion market, even before Gildan brings on it’s increasingly cost-advantaged additional Bangladesh capacity in 2H23 / 2024.  Bella + Canvas’s struggles are not as clear as Next Level’s, but we have heard that Bella + Canvas recently opened and then subsequently had to close a cutting facility in Alabama, had to move some distribution from California to Nevada which has been operationally difficult, and has combined the business financially with their retail yoga brand Alo (which is doing very well), so they can focus on that.  Next Level’s problems, on the other hand, seem more dire and immediate – as a VP at distributor Sub Apparel said, “Next Level is at the edge of a cliff”.  Indicative of Next Level’s precarious position, S&P downgraded their debt in August, citing EBITDA declining ~50%.  For a business where capital requirements for inventory availability are material, Next Leve’s financial distress could compound its problems quickly (we’ve seen this in other industries like with Serta Simmons in the mattress industry).  Gildan’s new Bangladesh capacity should only reinforce the woes of Bella + Canvas and Next Level, and likely effectively push both out of the market (Bella + Canvas could remain, just much smaller in blanks and more focused on Alo, and Next Level likely goes out of business).  Gildan’s cost advantage in rung-spun / fashion as a result of the new Bangladesh capacity should grow by a significant amount – while mgmt. has not quantified the exact amount, they’ve said that with their new Bangladesh capacity they could make a ring-spun / fashion shirt the opening price point in their lineup if they wanted to.  Consider that basic / fashion are 50/50 in terms of dollars but 66/33 in terms of unit, and Gildan is already producing fashion shirts at ~70% of the price point of competitors while earnings significantly higher margins – the implications re: Gildan’s new ring-spun / fashion cost position are significant.  While Gildan is bringing many of their manufacturing practices from Honduras to Bangladesh, the main cost savings will be labor, as fashion shirts require ~10x the labor of a basic shirt.

In summary, Gildan is a high quality, advantaged business that is misunderstood and is poised to accelerate growth and share gains.  Pre-COVID the company had self-induced headwinds as their “Back To Basics” strategy rationalized their product offering and raised their operating margins and RONA.  Post COVID the company struggled with unique and episodic demand / hurricane / capacity issues, and now that operations have normalized, their industry is effectively in a recession.  However, with significant cost-advantaged Bangladesh capacity coming online, and competitors struggling, we expect that over the next several years, as industry growth eventually reaccelerates, Gildan will steadily accrue large share gains in the ring-spun / fashion segment of the market.  While this occurs, we expect the business to generate significant FCF (capex peaks this year from the Bangladesh expansion) and continue to buy back material amounts of their stock.  In short, Gildan is poised to re-emerge as a quality growth company while its shares are priced as a no-growth, cyclical business.

Valuation

Gildan has historically traded between 12x and 18x earnings, averaging about 15x.  We believe that is a fair, if not cheap, multiple for a business that is competitively advantaged, generates high returns on capital, and has good growth opportunities.  The business is currently trading at ~10x what it will likely earn this year, and net leverage is only 1.8x.  With industry volumes below normal, the company’s competitive advantage growing as a result of their additional Bangladesh ring-spun / fashion capacity with which they are well positioned to take market share, we believe that the company should be able to consistently grow M-HSD top line once the environment normalizes.  With some operating leverage, and management’s history and indication of buying back ~5% of the float every year, earnings should be able to sustainably grow double digits.  A re-rating to ~15x with that kind of earnings growth could result in a multi-year IRR of >20%.  With a dominant, cash-flow generative business that is only 1.8x levered, we believe that is an attractive risk / reward.

Risks

Economic:  There is cyclicality in this business and things could get worse before they get better.

Management:  Glenn is a key figure at Gildan; it would likely be detrimental to the business if something were to happen to him.

Tax:  Gildan’s tax rate will likely increase as a result of the global minimum tax.  Gildan enjoys a L-MSD tax rate right now, and the GMT is 15%.  The company expects it’s operating jurisdictions to introduce tax incentives to offset much of this increase, the increase would likely affect competitors after-tax cost structure as well, and the company would remain extremely profitable, but it is a risk / unkown.

Catalyst

Earnings & share gains.