Quick Value 2.20.23

A turnaround stock in the retail industry

Feb 22, 2023

This week’s Quick Value is a tad late partly due to the holiday and partly due to a much needed vacation (without kids!). Today’s post is for paid subscribers and will be back next week with a free post. It’s an incredibly affordable subscription with tons of actionable value ideas (ones that don’t get a lot of coverage too!):

I wrote a lengthy piece on 10 Ideas for 2023 that’s included in the subscription but can also be purchased as a one-off e-book here.

Market Performance

Market Stats

Oil company cash flow performance at various oil prices dating back to 2000. This was a really interesting chart from @GuyImpatient on twitter. Incredible to see the 20-year stretch of negative FCF followed by massive cash generation in just a 3-year period from 2021-2023

Quick Value

Hanesbrands ($HBI)

This is an incredibly beaten up stock with shares down >70% since their peak in mid-2021. Like other retailers, they saw a huge bump in performance during the pandemic (specifically calendar year 2021). But also like many others, they plowed too many resources into working capital at the same time the business was normalizing to pre-pandemic performance levels.

What they do…

HBI runs an “innerwear and activewear” apparel brand. They are all highly recognizable names like Hanes, Champion, Playtex, etc.

Their products are sold through several distribution channels including mass market (i.e. Walmart), department stores, e-commerce, and company-owned retail locations.

Why it’s interesting…

1) Ripped off the dividend band-aid — HBI has historically paid a big dividend and the yield kept climbing post-COVID. The dividend consumed $1.5bn in cash during the 7-year period since 2016… that’s a huge number for what’s now a $1.9bn market cap. They’ve never made any real progress in chipping away at their debt and finally threw in the towel to clean things up.

2) Cash generator — I’m a big fan of highly cash generative businesses and HBI has historically generated >$600m annual operating cash flow and >$500m in FCF. That works out to an incredibly cheap valuation at today’s price. The caveat is that cash flow and FCF went negative in 2022 from working capital investments. Here’s a look at sources and uses of cash since 2016:

Notable takeaways:

Pre-working capital HBI was still cash flow positive in 2022 (though down big from 2021 and 2020)
Cumulative FCF from 2016-2022 was $2.8bn (including the negative $471m in 2022)… that’s 1.5x the current market cap
Dividends consumed $1.5bn, more than 50% of FCF during this 7-year period
Borrowed $1.2bn for an acquisition in 2016 and repaid zero debt from 2017-2022 (yikes)
Acquisitions and buybacks totaled >$1bn apiece or 1/3 of cumulative FCF

3) Margins impacted by supply chain — EBITDA fell from $1bn+ pre-pandemic to an estimated $618m in 2023 and EPS is expected to fall from $0.98/sh in 2022 to $0.31-0.42/sh in 2023.

Like other retailers facing gross margin pressures from supply chain purchases during the pandemic, this looks like it could be temporary. When a retailer capitalizes inventory at substantially higher costs, they have to sell through that higher cost inventory in the future which could meaningfully dent margins. They’re sort of hinting at this in the 10-K regarding inflation/costs:

So where are the bright spots?

HBI looks like they might be in a pretty distressed situation with sales falling slightly, margins coming down, the dividend getting cut, etc. I haven’t done any work on potential sales trends in 2023-2024+ but my guess is HBI is feeling some inventory destocking at retailers right now.

On the bright side, cash flow looks like it’s starting to return to normal with a $500m operating cash flow guide for 2023 which would be ~75% of pre-pandemic levels. Earnings are still positive at an expected $0.31-0.42/share. Here is the rest of the 2023 outlook commentary:

HBI has 350m shares outstanding and a $5.40 share price for a $1.9bn market cap. Net debt is $3.6bn = $5.5bn enterprise value. EBITDA fell from $1.1bn in 2021 to $795m in 2022 and likely to fall further in 2023. If EBITDA climbs back to $795m in 2024 that’d be 7x EV/EBITDA and 4.5x leverage. On a cash flow basis, the stock currently trades at 3.8x cash flow or 5.4x FCF based on 2023 guide.

I don’t own any shares of this one but it’s definitely on my shortlist. It looks like roadkill and has very real risks. BUT, I like that part of the turnaround should be taken care of by accrual inventory accounting and the rebound in cash flow is promising. It’s hard to tell if the business is deteriorating or bending from macro issues and that’s an area I’d like to feel more comfortable before investing (i.e. what will this business look like in 2024-2025?).