Description

WJV recently posted a long recommendation on Hanesbrands.  WJV's write-up provides a good summary of HBI's business as well as the competitive landscape, and I would refer you to WJV's write-up for additional background.  Unlike WJV, I'm skeptical that HBI's rollup strategy has created the value that's reflected in the current stock price amidst negligible organic growth, which has recently turn negative.  We think HBI is a short at these levels and provide more details on this thesis below.

Hanesbrands Inc. (NYSE:HBI) is a global consumer apparel company with a leading position in basics attire including T-shirts, bras, panties, men's and kid's underwear, socks, hosiery, casualwear and activewear. The Company’s key brands include Hanes, Champion, Playtex, Bali, DIM and Maidenform. Unlike most apparel companies, Hanesbrands primarily operates its own manufacturing facilities. Approximately 91% of the Company’s revenue is generated through wholesale sales with the remaining sales through direct to consumer channels. In 2015, 23%, 15% and 5% of the Company’s sales were to Walmart, Target and Kohl’s, respectively. Hanesbrands was spun off from Sara Lee Corporation in 2006.

Despite competing in a highly price competitive area of the apparel industry, Hanesbrands was one of the best performing stocks during the past 5 years, returning over 600% from its lows in 2011 to its highs in 2015. We believe a primary reason for Hanesbrands’ outperformance was an aggressive acquisition strategy, which the Company believes creates costs savings through manufacturing efficiencies and increased scale to serve retailers. We believe the Company has reached its debt capacity for acquisitions, the negative organic growth of the business is starting to show, and the CEO who engineered the debt-funded acquisition strategy and aggressive accounting-based “non-GAAP earnings growth” story has just resigned from the helm after unloading most of his personal shareholdings in the past few months – all signs that point to a material de-rating of HBI stock in the coming quarters.

As a result of the acquisitions in the past five years, Hanesbrands was able to deliver “adjusted” annual EPS growth in excess of 20%, resulting in a change in market perception of the company as a growth story. Specifically, Hanesbrands has spent $2.5 billion on acquisitions since 2010, which led to an increase in the Company’s enterprise value from $4 billion to $14 billion, and a 6-fold increase in its stock price.

Given how important the Company’s roll-up strategy has been to its stock price performance, we decided to dig into the Company’s track record of integrating their past acquisitions to generate earnings growth. What we uncovered was a surprisingly high usage of non-GAAP addbacks for integration charges that accounted for a substantial difference between impressive adjusted EPS growth and mediocre GAAP EPS growth. As shown below, these addbacks have grown significantly and represented 57% of GAAP EPS in 2015. Without the addbacks, there has not been much earnings growth.

If these addbacks are truly one-time in nature, then evaluating Hanesbrands on these adjusted metrics is appropriate. However, when we compare these addbacks to the purchase price for these acquisitions, we calculate that the cumulative charges (addbacks) represent nearly 50% of the acquired purchase price of the assets! We cannot recall many roll-up stories where the proportion of integration charges to purchase price is even in the same ballpark.

Further, when we evaluate the “costs to achieve” these synergies, the numbers also look egregious. While the Company only provides year 3 fully-synergized acquisition multiples, if we assume that the acquired companies can grow their EBITDA at an 8% rate, then it costs the Company 9x the annualized synergy target to achieve the synergies. In other words, Hanesbrands has been acquiring companies at 8.4x EBITDA (a high multiple relative to historical industry valuations) and is then taking additional charges to achieve synergies in the tune of a 9-year payback. Further, acquisitions for Hanesbrands are getting more expensive as illustrated by the recent $800 million acquisition of Pacific Brands for over 10x projected 2016 EBITDA.  We believe these metrics call into question the market’s perception of Hanesbrands as a high return M&A acquirer.

We also find the sequencing of guidance around these integration charges in 2015 unusual, and believe it suggests that these non-GAAP charges are “massaging” operational expenses and helping to temporarily boost non-GAAP earnings. For instance, despite missing revenue guidance throughout 2015, the Company was able to hit the top end of its adjusted EPS guidance. However, this was achieved with the Company increasing the full year non-GAAP integration cost guidance in every quarter through the year, from an initial guidance of $150 - $170 million to the ending annual charges of $266 million. While adjusted EPS hit the top end of the Company’s range of $1.61 - $1.66, GAAP EPS for 2015 came in at only $1.06, a far miss from the Company’s initial guidance of $1.39 - $1.50. Without these discretionary “one-time” adjustments, which the company has been making for several years now, there isn’t much in the way of actual earnings.

Additionally, given the perception of Hanesbrands as a growth story, we were also interested in figuring out the Company’s organic growth rate, a number the Company doesn’t openly disclose. Based on our calculations below, Hanesbrands saw no organic growth in 2013 and 2014, and negative organic growth in 2015, which had continued into 2016. This is perhaps not surprising, as the Company has no significant ecommerce platform of note, their largest customers (Walmart, Target and Kohl’s) have all struggled with negative traffic trends and have in turn pressured their suppliers for additional cost cuts. Since it is normally challenging to achieve margin expansion with negative organic growth, we believe that the margin expansion guided to by the Company is unlikely to be achieved. The non-GAAP earnings growth the Company has focused investors on has been achieved primarily through the recurring adjustments and accounting gimmicks, while the underlying business has not grown much and in recent quarters has started to decline organically.

While the items listed above are red flags, they don’t necessarily prove that the earnings growth is not achievable at some point in the future as these acquisitions are fully integrated. Notably, if GAAP and adjusted EPS are set to converge in the future at 20%+ per annum growth rates, one would expect to see management’s actions align with this outcome given that the stock is currently trading at 13.3x 2016E non-GAAP EPS (compared to over 20x 2016E GAAP EPS). However, CEO Richard Noll’s recent actions suggest the opposite. For example, after increasing guidance in Q3’15 in a very weak retail environment (resulting in HBI’s stock jumping 20%), CEO Noll sold over 50% of his personal shareholdings for $30 million. Subsequently a few months later, Hanesbrands missed its recently increased guidance during the Q4 earnings report in February 2016, and the stock fell 15%. Following the earnings call, the Company accelerated its share repurchases to boost its share price. A few weeks ago, CEO Noll announced his resignation and retirement at the age of 58, which we find to be unusual timing, as the debt-financed roll-up story he has created over the past few years comes to an end. In addition, we find the timing suspect as the Company’s inventory grew 16% in the past quarter compared to only 0.8% sales growth. The Company also provided guidance that it can sell the excess inventory without taking a markdown. Eventually, we believe the “integration addbacks” the Company has taken will have to cycle through, and the true earnings power of the Company will emerge. We expect the new CEO to reset and lower earnings expectations when he takes the helm later this year.

Lastly, Hanesbrands faces increasing competition from Gildan Activewear, who has invested heavily in their manufacturing footprint over the last few years. This has allowed Gildan to achieve dominant market share in the U.S. printwear business (the wholesale selling of t-shirt and other blanks to printing companies).  Gildan has now turned its attention to innerwear and has been successful in winning market share in the men’s underwear market. With a manufacturing footprint that allows Gildan to produce higher quality product at a lower price, we expect the company to continue to pose a threat to Hanesbrands’ domestic market share.

In conclusion, we see a lot of red flags in Hanesbrands, with catalysts that should play out over the second half of 2016. We believe that true earnings power for Hanesbrands, adjusted for recent acquisitions, is between $1.30 - $1.50. With negative organic growth, 3x leverage and our expectation for a declining margin outlook, we believe fair value for Hanesbrands is $15 per share, and the share price is likely to meet a similar fate as other such roll-up stories with aggressive accounting-based non-GAAP “earnings growth” that have ended in recent quarters.  

Catalyst

• Q2 and Q3 Earnings
• Lowering of Full Year GAAP guidance (may come on Q3 call after CEO Noll steps down)
• Insider Sales
• Earnings and additional details from large customers (Walmart, Target, Kohls) on cost cutting initiatives with suppliers