About a year and a half ago, GuruFocus contributor Jonathon Poland wrote an article titled, “Hanesbrands Is Worth Owning Under $18”. Well, Hanesbrands HBI now is worth much less than $18; at the close of trading on April 13, it was priced at just $9.35.
So is this a good time to buy, or should we consider buying it at all?
Currently, Hanesbrands is also the most undervalued stock on the GuruFocus Undervalued Predictable list. This list is created by screening for stocks that are undervalued based on the relationship between their market price and a discounted cash flow analysis, and by screening for stocks that have the highest consistency in their earnings (at least four out of five stars in GuruFocus rankings).
But before we rush out and buy the company right now, we need to examine why investors were losing interest in it—well before Covid-19 arrived on the scene. Here is a 10-year chart:
Actually, it appears the company was doing reasonably well, but the retailers to which it sells have not, raising doubts about suppliers like Hanesbrands. Not that it wasn’t without its problems in the mid-2010s, including slowing revenue growth for some important lines and missed earnings estimates. Generally, though, all apparel companies that served the retail industry were struggling.
Most recently, since just after mid-February, it’s share price has been affected by the current pandemic. Not that its situation is entirely bad news; in a press release issued on April 7, the company announced it had taken several measures to reduce cash flow (including limits on discretionary spending and cutting executive pay).
Importantly, it also announced it was part of a consortium of apparel companies that are making 320 million facemasks for the U.S. Department of Health and Human Services. By the date of the press release, it had already delivered some 10 million masks and expected production to ramp up to 40 million per week. The company did not report on what that might mean financially, but it obviously should help bring in revenue while its 1,200 retail stores are shuttered.
Turning to quantitative matters, we will examine Hanesbrands with the Macpherson model, a simplified version of the screening done by GuruFocus contributor and Chief Investment Officer at Nintai Investments, Thomas Macpherson (information about the model available here and here).
Moat
To determine whether a company has a wide moat, Macpherson applies two criteria (I use GuruFocus data):
- Return on capital: The 10-year median must be above 15%. Hanesbrands gets over that hurdle with a 15.57% return on capital.
- Return on tangible equity: The company has negative ROTE, which appears to be due to goodwill built up since 2010. By way of explanation, tangible equity is calculated by subtracting intangible assets from total stockholders’ equity. When intangible assets, such as goodwill, are greater than that total stockholder’s equity, then the return on tangible equity is negative. Goodwill is incurred when a company pays a premium over the market price to acquire another company, something Hanesbrands has done quite often.
Based on the information here, I’m going to give Hanesbrands a pass on having a good economic moat. The acquisitions it made has allowed it to buy premium brands, customers and distribution systems, all of which widen a company’s competitive advantage.
Financial strength
Next, we turn to financial strength, where the model stipulates a cash-to-debt minimum value of 100 and a GuruFocus financial strength minimum of 9. As this screenshot shows, Hanesbrands fails on both measures:
From the data in this table, we can see the company’s Achilles heel is debt. This chart shows how much the long-term debt and capital lease obligations have grown:
Profitability
Third, Macpherson is looking for a company that is robustly profitable, a company that scores at least a 9 on GuruFocus ratings. Hanesbrands achieves that, and thus passes this criterion.
Undervalued
Here we’re looking at discounted cash flow values that are greater than the current price, based on either earnings or free cash flow (Macpherson uses three types of cash flow, but we will use the two provided by GuruFocus):
- The earnings-based DCF provides a “fair” or intrinsic value of $35, making the current price of $9.35 a 73% discount.
- The free cash flow-based DCF provides a value of $55, making the current price an 83% discount.
Since both methods provide a robust margin of safety, we will give Hanesbrands a pass.
Overall, the company has done reasonably well on the Macpherson model criteria, garnering passes on the existence of a moat, profitability and the depth of its undervaluation. It does fail on the issue of financial strength, because of leverage.
Specifically, the financial statements to the end of calendar 2019 show:
- Total current assets: $3,225 million.
- Total current liabilities: $1,771 million.
- Total long-term liabilities: $4,320 million.
The April 7 press release included these words from CEO Gerald Evans Jr.: “We also are proactively taking measures to assure balance sheet flexibility and liquidity, seeking to limit the impact on employees, and making fast-recovery plans to take advantage of market needs when the pandemic wanes.” Its war chest includes more than $1 billion in cash.
Ownership
So what do others think?
At the end of calendar 2019, there were 13 gurus with positions in Hanesbrands. The three biggest were Diamond Hill Capital (Trades, Portfolio) with more than 15 million shares, the Parnassus Endeavor Fund (Trades, Portfolio) with more than 10 million and Jim Simons of Renaissance Technologies with more than 2 million shares. Of the 10 last transactions before Dec. 31, seven were additions or new buys, while three were reductions.
Jerome Dodson (Trades, Portfolio) of the Parnassus Endeavor Fund frequently references Hanesbrands, which rose 23% in 2019, as one of his top performers. He noted, “Stronger-than-expected performances in the company’s Champion brand and international businesses led management to raise its revenue guidance for fiscal-2019. The company also used its cash flows to pay down debt to improve its capital structure.” He made those comments in January, before the market meltdown and before the company pulled its guidance for the year.
Institutional shareholders held just over two-thirds of outstanding shares while insiders held 1.71%, a figure that has gone up since the market began plummeting. Among those buying were Gerald Evans, who bought 10,000 shares to add to his roughly 2 million shares.
Capital allocation
Before hitting the current tough spot, Hanesbrands had this approach to capital allocation (as shown in this slide from its September 2019 investor presentation):
Dividends
One of the consequences of a price plunge is a spike in the dividend rate. GuruFocus reports that the dividend yield has jumped to 6.4%, up substantially since the pandemic hit.
Is it sustainable at that rate? That’s a good question because the payout ratio has risen to 37%, which is above the 25% to 30% range shown in the capital allocation slide above. There are pros and cons, but I would expect the company to wait at least a couple of months before deciding what to do with it.
Conclusion
Hanesbrands is a big bargain at the moment—if you can live with the big debt it holds. It appears to have a plan to get through at least a short period of adversity, one that involves reducing costs and maintaining its financial flexibility.
To its credit, the company has also shown adaptability or nimbleness in jumping on the opportunity to manufacture and sell face masks in the short term. While we can’t know what will happen later, it is reassuring to know the company has the resources and management to keep the company viable.
For strict value investors, a position in Hanesbrands would be ruled out by its debt load. On the other hand, more aggressive investors will see attractive capital gains potential and an excellent dividend while waiting.
Disclosure: This article is only an introduction to the company and investors must do their own due diligence. I do not own shares in it and do not expect to buy any in the next 72 hours.
Read more here:
- Book of Value: Buffett, IBM and the Refutation Process
- Book of Value: Adding Growth to a Defensive Portfolio
- Book of Value: Valuation and Creating a Core Portfolio
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