With the U.S. Federal Reserve and other central banks raising interest rates to curb inflation, the stock prices of many companies have been shrinking. Those with high debt are in the most trouble, as it's no longer so easy to pay off debt by taking on even more debt.
One example is Hanesbrands Inc. (HBI, Financial), an apparel company with brands like Hanes, Champion, Maidenform and others. While the company is screening well on value criteria with a price-earnings ratio of around 7 and a significantly undervalued rating on the GF Value chart, I think this is a value trap.
The problem is, as mentioned above, the high debt. Hanesbrands is pickled in it. The equity cushion is slim and on the asset side there are a lot of intangible assets (due to M&A) which are at risk of being written down in a recession.
Financial strength is less than comfortable:
| Financial Strength | |||
| GF financial strength rank: 4 /10 | Current | Industry Median | Historical Median |
| Cash-to-Debt | 0.10 | 0.50 | 0.08 |
| Equity-to-Asset | 0.11 | 0.50 | 0.15 |
| Interest Coverage | 5.17 | 7.62 | 4.85 |
The following chart shows Hanesbrands' debt per share and price per share. Debt per share has been rising over the years. As we can see, Hanesbrands barely survived the financial crisis, even though debt per share in 2007 was half of where it is currently.
Looking at the company's debt table organized by type below, we see that big chunk of debt ($900 million) is coming due in May 2024. Another 1.9 billion will have to re-financed in 2026. The refinancing will surely be at a much higher rate.
| As of April 2, 2022 | Interest Rate | Principal Amount ($) | Maturity Date |
| Senior Secured Credit Facility: | |||
| Revolving Loan Facility | 1.69% | 20,000 | November 2026 |
| Term Loan A | 1.75% | 993,750 | November 2026 |
| 4.875% Senior Notes | 4.88% | 900,000 | May 2026 |
| 4.625% Senior Notes | 4.63% | 900,000 | May 2024 |
| 3.5% Senior Notes | 3.50% | 552,425 | June 2024 |
| Accounts Receivable Securitization Facility | 1.25% | 135,500 | June 2022 |
| Subtotal | 3,501,675 | ||
| Less long-term debt issuance costs | 16,133 | ||
| Less current maturities | 160,500 | ||
| Total | 3,325,042 |
While Hanebrands' interest coverage of 5.19 currently is comfortable, this can drop quite fast in a recession, as happened in 2009. So investors should pay close attention to debt.
The company has not made much progress on reducing its debt load over the last three years either.
The company's debt is curently rated as Ba3 by Moody's (MCO, Financial) and BB by S&P Global (SPGI, Financial). As of yet there is no sign of distress.
Source: FINRA
However, yields on less than investment grade credit are rising.
Conclusion
Hanesbrands, in spite of screening well for value due to high cash flow and a low price-earnings ratio, is very indebted. This makes it higher risk as interest rates rise and a recession may hit in the next couple of years. While a recession is not a foregone conclusion, most often a Fed tightening cycle does cause a recession.
According to prominent economist David Rosenberg writing in the Financial Post:
"The Federal Reserve has a very poor track record of raising interest rates without pushing the economy into a recession. In fact, going back to 1955, there has never been a quarter with average inflation above four per cent and an unemployment rate below five per cent that was not followed by a recession within the next two years."
Investors should remain cautious. While I think Hanesbrands should be able survive this (it can also cut or eliminate its dividend if push came to shove), the stock price could drop to mid-single digits from here.
