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Citi Research Calls Hanesbrands a Warren Buffett Buy - It's Not

November 21, 2012 | About:
Citi Research wrote a research note on Nov. 14, 2012, calling Hanesbrands Inc. (HBI) as a classic Warren Buffett investment. Analysts Susan Anderson and Kate McShane cite characteristics of the stock such as low debt, high FCF, high scale/market share, stable returns and low cash usage to support their call.

HBI is a consumer goods company, which manufactures, sources and sells a broad range of basic apparel such as T-shirts, bras, panties, men’s underwear, kids’ underwear, casual wear, activewear, socks and hosiery. HBI was spun off from Sara Lee in 2006.

Let's put HBI through the test.

HBI is highly geared with a debt-to-equity ratio of 243% and a net gearing of 219%. Although HBI plans to pay off its $500 million of 8 percent notes, reducing bond debt to approximately $1 billion by the end of 2013 and lowering its leverage to under 200%, two times debt-to-equity ratio is hardly low debt by any standards. Even if we used Buffett's criteria for low debt — a low multiple of long term debt/earnings, long-term debt of $1.5 billion will be repaid in full with five and half years of fiscal year 2011 net income of $267 million. HBI still failed the test on low debt.

For the past 10 years, HBI's gross margins and operating margins have not fallen below 31% and 7%, respectively. HBI has also achieved a five-year average ROE of 44.8% and a five-year book value per share CAGR of 57.5%. HBI is also profitable and operating cash flow positive in every single year for the past decade. Except for 2008, HBI also generated positive free cash flow every year since 2002, with capital expenditures as a percentage of sales below 5%. On high FCF, stable returns and low cash usage, HBI passed the test with flying colors.

According to The NPD Group/Consumer Tracking Service, or “NPD,” HBI's brands held either the No. 1 or No. 2 U.S. market position by units sold in most product categories in which it competes, for the 12-month period ended Nov. 30, 2011. HBI's leading brand Hanes is the No. 1 brand of total apparel in the U.S. as well as the leading brand of men’s and boys’ underwear, women’s and girls’ panties, and socks for the family by units sold in 2011. HBI passed the test on market share.

On Feb. 1, 2007, HBI's board of directors granted authority for the repurchase of up to 10 million shares of its common stock. From 2007 to 2011, HBI has purchased 2.8 million shares of its common stock at a cost of $75 million (average price per share of $26.33). The primary objective of HBI's share repurchase program is to reduce the impact of dilution caused by the exercise of options and vesting of stock unit awards. This is supported by the fact that shares outstanding have increased by 2% since 2007, implying that share repurchases did not create value, but purely reduced the impact of options dilution as stated by management.

Year to date, HBI's share price is up more than 50% and valuations reflect that. HBI is currently trading at a trailing 12-months P/E of 17.79 and a trailing 12 months EV/EBITDA of 11.11. In the past five years, HBI's historical high and low P/E valuations were 45x and 8x in 2009 and 2011, respectively. For the past six months, three insiders have sold 201,388 shares for $6,560,585. Kevin Oliver, the chief human resources officer, was the chief contributor — he sold more than 150,000 of the 201,388 share sold in the past six months.

Other business risks include high customer concentration risk, cotton prices and a spike in inventory days. HBI's top 10 customers accounted for 62% of its net sales and its top two customers, Walmart and Target, accounted for 25% and 16% of net sales, respectively. Cotton is the primary raw material used to manufacture many of HBI’s products and is purchased at market prices. Although the cost of cotton used in goods manufactured has historically represented only 6% of HBI's cost of sales, it rose to around 12% in 2011 as a result of cost inflation. Inventory days for 2011 and the trailing 12 months have increased to 170 days, significantly higher than the historical average of around 150 days.

Conclusion

I disagree with the analysts that HBI is a Warren Buffett buy. While HBI passed the tests on high FCF, high scale/market share, stable returns and low cash usage, the huge debt burden is still a serious concern for HBI, notwithstanding the deleveraging in 2013. Lofty valuations and the lack of a meaningful capital return policy are also negatives aspects.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


Rating: 3.3/5 (13 votes)

Comments

stevenramsey
Stevenramsey - 1 year ago
I can see how Hanes fits the "Fruit of the Loom" model that Berkshire owns. I can agree with both you and the Citi analyst on the surface. I guess my comments/questions to you are:

- What is the EBIT or FCF to interest expense ratio? I would say that while Debt-to-Equity is sometimes a concern. If the leverage is used prudently, it is a good thing. John Malone loves leverage-able, high FCF businesses. Would you say Hanes is one of those?

- If they're not buying back a decent amount of the stock every year, then I would say that the usage of the debt may not be as good as it could be.

- And like you mentioned, the price isn't necessarily cheap on PE basis. But what is the yield on an EBIT/EV ratio?
marklin
Marklin - 1 year ago


Hi Steven, thanks for your comments.

My responses are as follows:

Firstly, the interest coverage ratio or EBIT to interest coverage ratio for the trailing twelve months is 2.5x, this is hardly comforting. If we used Buffett's criteria for low debt — a low multiple of long term debt/earnings, long-term debt of $1.5 billion will be repaid in full with five and half years of fiscal year 2011 net income of $267 million.

Secondly, they are buying back a decent amount of stock every year - 2.8 million shares in 4 years from 2007 to 2011. Unfortunately, share repurchases have barely offset the impact of dilution caused by the exercise of options and vesting of stock unit awards. This is supported by the fact that shares outstanding have increased by 2% since 2007.

Lastly, HBI trades at a trailing twelve months EV/EBIT of 14.1, if we flip that over, it will give a 7% on an EBIT/EV ratio.

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