Hanesbrands Q3: Looking To Fix Or Sell Champion (HBI)

In March, I claimed that while Hanesbrands (NYSE:HBI) had problems I thought they were fixable and gave a Buy rating. In August, meanwhile, I thought the company was showing progress in fixing its issues and reiterated my Buy. The stock has performed poorly recently. While the company has been able to clean up the inventory issues at its main Hanes brand as I thought it could, issues with the Champion brand have lingered longer than I expected and appear likely to continue for a while. Let’s catch-up on the stock, which reported its Q3 results earlier this month.

Company Profile

As a quick reminder, HBI owns a variety of apparel brands, although its two largest and most important are Hanes and Champion. Hanes focuses on basic items such as undergarments and t-shirts, while Champion is known for its activewear. Most of its items are sold through the wholesale channel, with Walmart (WMT) its largest customer accounting for over 15% of sales. The company manufactures over 70% of the apparel it sells at its own facilities or dedicated contractors, which is pretty rare for apparel brands nowadays.

Q3 Results

Like many apparel and other companies that sell into the wholesale channel, HBI ran into trouble last year after retailers over-ordered due to prior supply chain issues related to Covid. The issue hit HBI particularly hard, however, due to its HBI’s vertically integrated model.

As such, when looking at a potential HBI recovery, inventory has been one of metrics I’ve paid particular attention to over the past few quarter since covering the stock. For Q3 reported on November 9th, the company was able to reduce inventory by -29%, or nearly $620 million, year over year and -17% sequentially to $1.52 billion. The company has been targeting inventory to be under $1.5 billion by fiscal year end, and looks well on its way to achieving that.

The Hanes brand has clearly been the stronger of HBI’s two brands, with Innerwear sales pretty steady, down -0.4% in Q3 to $622.6 million. However, activewear sells sank -16.8% to $383.6 million, with Champion sales down -16% in the U.S. and international sales -22%, or -24% in constant currencies. Total Champion sales dropped -19%, or -20% in constant currencies. Overall sales decreased -9.5%, or -9.3% in constant currencies.

Champion has continued to struggle, and HBI is looking to both improve the brand and its supply chain. That said it doesn’t expect a meaningful improvement until the next fall/winter sell-in, and such it is also looking to possibly sell the business.

On its Q3 earnings call, CEO Stephen Bratspies said:

“During the quarter, we completed several strategic actions in the Champion business related to inventory cleanup, store exits and operational streamlining. … In addition, we continued our efforts to position Champion for growth by improving our product offering and channel mix, driving our channel segmentation strategy and working to strengthen Champion’s brand position with new marketing ahead of the launch of our fall/winter 2024 product line, which is our first global line for the new team. In fact, as we conduct our account meetings for our fall/winter 2024 line, we received consistent positive reviews, particularly around the elevation of the product and our focus and connectivity to the brand’s heritage. And we believe we have opportunities to further increase our distribution in key channels. We’re also successfully reigniting brand heat, driven by our good progress with pinnacle product offerings and accounts. While small in volume, these programs can generate a big and meaningful brand halo effect.“

On the margin front, the company saw some progress on its adjusted gross margins, which rose 100 basis points year over year and 190 basis points sequentially to 35.5%. The company is still selling through some higher cost inventory when ocean freight costs were higher, but saw some benefit from increased prices, higher manufacturing utilization, and cost initiatives. It expects to see adjusted gross margins in the high 30% range in Q4 to about 37.5%.

HBI’s debt level is another issue the company is dealing with and it ended the quarter with leverage of 5.5x. Reducing inventory helped the company generate $155 million in operating cash flow in Q3 and $153 million in free cash flow. It paid down $144 million in debt in the quarter. HBI is still projecting OCF of around $500 million for the year and free cash flow of about $450 million. The company plans to pay down more than $400 million in debt this year.

Looking forward, the company is forecasting full-year sales of between $5.7 billion, down from a prior outlook of $5.8-$5.9 billion. It is looking for an adjusted operating profit of $425 million, at the low end of its $425-$475 million previous guidance. It forecast adjusted EPS of 12 cents versus a prior outlook of between 16-30 cents.

For Q4, it is looking for revenue to decline by -8% to $1.36 billion with an adjusted operating profit of about $131million and adjusted EPS of 9 cents.

After the quarter, the company temporarily added three new board members at the behest of activist Barington Capital. The new members bring the board up to 13, and it will return to 11 after its 2024 shareholder meeting. Barington has publicly called for the company to reduce SG&A by $300 million, consolidate facilities to improve gross margins, and reduce inventory. The firm has said while a sale of Champion would make strategic sense, it needs to be done at an appropriate value.

HBI continues to make progress in righting the ship, although it’s not happening quickly. It’s done a nice job of improving its inventory position, which is also helping improve its gross margins. Hanes sales, meanwhile, have held up well. The Champion brand, however, remains an issue, and the progress on turning it around didn’t really show up in its results this quarter, which is a disappointment.

Looking Ahead

Looking ahead, the Champion brand will likely continue to remain an issue for the foreseeable future. The brand still appears to have too much inventory in the channel that needs to be worked through, and sales for the brand have been poor. The company has some plans in place for the brand, but it is difficult to fully execute them given the continued channel problems. However, it did sign a licensing deal in September with G-III Apparel (GIII) to help design, produce and distribute the brand in an effort to expand its reach.

While HBI has discussed selling the brand and that it has received strong initial interest, the company wouldn’t exactly be selling it from a point of strength, or in a good macro market, if that is the route it decides to go.

I’d expect the Champion brand to take at least a year to turnaround, or for the company to sell it next year if it gets a good enough offer.

Valuation

HBI currently trades around 8.1x the 2024 consensus EBITDA of $651.6 million and about 7.2x the 2025 consensus of $726.4 million.

It trades at a forward PE of 8.3x the 2024 consensus of 48 cents and 5.2x the 2025 consensus of 76 cents.

Revenue growth is expected to be -8.6% this year, and -9.5% in 2024. Margin improvement is thus the biggest driver of EPS and EBITDA growth from 2023 to 2024.

Given its high debt to market cap ratio, HBI is very much a stub-like equity. As such, small multiple movements and debt reduction can have pretty large impacts on the stock and how its valued. Given a large range of outcomes and how small multiple difference can have a big range on the stock price, placing a fair value on the stock is difficult. That said, with balance sheet improvements through debt reduction, improved operations, and multiple expansion can add up to some pretty large gains in these types of stocks if things play out favorably. Reduce debt by $700 million over the next two years, return EBITDA to $800 million in 2026 (the company did $800 or more in EBITDA every year between 2015-2022), place a 10x multiple on that, and you get a $14 stock in a couple years.

Conclusion

Because of how HBI reports its segments, it’s not entirely possible to tell what Champion sales and operating profits are, but recent reports peg sales around $1.5-2.0 billion a year. Lower end athletic apparel public companies tend to trade around 0.5x sales, which would value the company at around between $750 million to $1 billion. However, analysts have pegged a potential $1.2-$1.7 billion value on the brand, given its likely prior solid margins. HBI previously bought Champion Europe for $228 million and Champion Japan for $30 million in 2016.

While a deal would reduce debt and leverage, as Champion may not being contributing much in EBITDA at this time, it also takes away any potential Champion rebound. Fortunately for HBI shareholder, the involvement of Barington and its board members likely stops the company from a fire sale. It also hopefully moves the company to cut corporate costs and to consolidate its manufacturing.

HBI remains a high risk/reward bet, but I’d continue to ride with Barington as it looks to help fix the company and extract value for shareholders. Barington isn’t in this for a small gain, and some patience will be required. The stock remains a “Buy.”