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Pencils Fund Purchase: Hanesbrands (HBI)
Purchase Price: 24.25
Purchase Date: 11/24/06
Shares Purchased: 7
Commission: 6.95
Business
Hanesbrands was founded in 1901, and operates in the textile industry under the brand names Hanes, Champion, Playtex, Bali, Just My Size, Outer Banks, Duofold, barely there, and Wonderbra. Some of their products include t-shirts, underwear, boxers, bras, hosiery, sleepwear, and other such products for men, women, and children. Hanesbrands was spun-off by Sara Lee on September 5, 2006.
Financials
Some quick numbers:
Market Cap 2.35B
Enterprise Value 4.75B
Employees 50,000
Shares Outstanding 96.31M
Qtrly Rev Growth (yoy) -1.70%
Revenue (ttm) 4.45B
Gross Margin (ttm) 33.36%
EBITDA (ttm) 573.44M
Profit Margin (ttm) 6.52%
Operating Margin (ttm) 9.82%
Return on Average Assets (mrq) 4.76%
Return on Average Equity (mrq) 12.45%
Net Income (ttm) 290.23M
EPS (ttm) 3.014
P/E (ttm) 8.11
P/S (ttm) 0.53
Total Cash (mrq) 209.08M
Total Debt (mrq) 2.60B
I'll admit that at first glance, these financials don't look to be real great. The declining income, good amount of debt, it certainly doesn't look like the best financials out there, and it isn't. But, if you see the headlines when Hanesbrands released earnings recently, you'd think the company would be going bankrupt. The truth is that all spin-offs experience higher costs, higher taxes, etc., after being spun-off. This is because they no longer get support from the parent company, and there are a good amount of costs related to splitting apart. So, obviously, higher costs dent margins, and lower margins usually mean lower income. It shouldn't be surprising to Wall Street or the individual investor to see this, it's a standard thing for a company that's just been spun-off three months before.
What I'm getting at is that this stock is priced like the company is doing terribly, losing business, etc., when it isn't. The company is experiencing higher costs for deciding to spin-off from it's former parent company, nothing sneaky. The P/E at 8.11 is extremely low considering that the industry average is 19.63. The P/S of .53 is also considerably low compared to the industry average of .72. Hanesbrands is simply being priced as if the company is experiencing huge problems, and that's the feeling I got when I was looking at its headlines before actually researching the business on my own. Since analysts put a lot onto the year-over-year (YOY) numbers, it's pretty obvious they'll be lower this time around, because they have more costs than last year, higher taxes, all of that. The company will continue to experience costs related to the spin-off, which are believed to amount to $300 million over the next three years.
The thing I love is that even with higher costs, the business is producing strong cash flow, increasing on a quarter-to-quarter basis (I'm not paying too much to YOY numbers, because of the difference of situation between the two). This is something analysts have not noted, all they are seeing is that net income is going down. If they actually did some research, they'd notice that Hanesbrands business is producing more cash flow, fueling its own growth, and not relying on the bank for finances. In short, the business is actually getting stronger while the market believes it is getting weaker. Management will be using this strong cash flow to primarily pay off debt and strengthen the balance sheet, as well as using it further to strengthen their brands and competitive position. So, the cash flow is being used in an excellent way.
I love where management is going with this company. They have shut down several plants to move to a less expensive area in the Caribbean basin. This will mean some extra costs for the next quarter, but management is thinking in the right direction, and actually doing something about lowering costs and improving efficiency, which will help them globalize the company. In the short-term, yes, it will add costs, but nothing could be better for the long-term than to improve efficiency. Management has big plans for Hanesbrands, and that's the main reason they separated from Sara Lee, they felt they have much more leverage and ability to expand the company and do what they feel is right. Something they are also doing
now is expanding into Asia. A recent survey found that in 85% of American households there is at least one Hanes product, so you can see they've done a great job of expanding into America. Asia is the next big market for Hanesbrands, management stated it in the recent conference call, and they've already taken action. On October 26, 2006, they announced that they'd agreed to
purchase a sewing plant in Thailand that has 1600 employees, and it marks the first Hanesbrands purchase in Asia. So, Asian expansion is underway and will be a huge part of the company's future, if all goes to what plans management has. This management team is very experienced, actually shows how they'll be doing what they're going to do in plain English, they outline why they expect certain growth, they know this business incredibly well.
Risks-- Competition - This is a very competitive business. The thing with it that I find interesting is that there isn't really as much brand loyalty with underwear as there is with brands like American Eagle. Many people just get the best deal they can get (from what I know and have seen). Hanesbrands has done a great job of getting the American person to buy their products, with 85% of American households having a Hanes product, as I mentioned before. So, we know they've been doing something right to get brand awareness and to convince people to get one of their products. But, with that said, competition is still an issue. You've got Fruit of the Loom (owned by Warren Buffett's Berkshire Hathaway), Joe Boxer, and many other brands involved in the same business. I believe Hanesbrands management team knows how to strengthen their brands, and I believe they'll do very well expanding the company into Asia while keeping their current position in other markets as well. To me, competition is the largest risk and will be the main thing I watch.
-- Costs - With the strong cash flow producing business, I don't think this will be an issue, but it's something to keep an eye on. We know the company will experience costs both from moving plants and with costs related to the spin-off. I think management knows how much they can expand without hurting the company (in fact, I'm sure about it), they know what their limit is. I'll be keeping an eye on if they can expand without hurting the process of paying off debt and without raising costs too much higher.
ValuationThis is, in my opinion, a very undervalued stock, simply because it's being priced very low on fears that don't have a foundation. A company valued at $2.35 billion without company problems should not have a P/E of 8.11 when the industry average is 19.63. I believe in five years we'll see a P/E of at least 13, there's a good chance we'll see it higher, but 13 will be my reasonable estimate. Management believes the company can achieve double digit growth for the next 3-5 years, with the costs and expansion taken into mind. I believe this is very much doable and will happen, because the expansion into Asia most likely will be really helping earnings growth within the next 3-5 years. For my reasonable estimate, I'll expect 12% annual earnings growth for the next five years from the current EPS of 3.01 with that P/E of 13:
3.01 * (1.12^5) * 13 = 68.96
This is close to a triple, with very reasonable estimates, which are very reasonable when considering that when a higher-valued (nearly four times more than Hanesbrands) close competitor, VF Corp., has a P/E above 15.
My low estimate is 9% annual earnings growth with a P/E of 9:
3.01 * (1.09^5) * 9 = 41.68
And my high estimate, which is 14% annual earnings growth to go along with a P/E of 15:
3.01 * (1.14^5) * 15 = 86.93
These calculations make me believe that we will see at least a double in share price over the next five years, but I plan to hold onto this investment for a much longer time, simply because Asia offers more than a few years of growth, it offers tremendous opportunity over the next 10-20 years.
ConclusionWith its strong brand names, experienced and intelligent management, strong cash flow producing business, and large opportunity in Asia, I think Hanesbrands is bargain at these levels, and I plan to stick with this investment for many years to come.
Tags:
hanesbrands, investing, pencils fund, stocks, valuation
Posted at: 08:07 AM | Add Comment
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