IntroductionAlthough Hanesbrands (NYSE: HBI) is in the midst of a multi-year turnaround plan, the company is currently generating negative Net Operating Income and negative margins. The discrepancy between expectations and actual results raises important questions about the company’s strategic decisions and its ability to achieve its long-term objectives.My outlook for Hanesbrands is moderately bearish. The company’s licensing agreement with G-III (Nasdaq: GIII) for the Champion brand does not appear to offer incremental upside at this point. In the event of a potential sale of the brand, Hanesbrands would be left primarily with its innerwear segment, which has limited growth prospects as a mature market.The company also faces challenges related to inventory management, resulting in substantial markdowns that adversely impact profit margins. While the active involvement of certain investors may push the company to optimize its balance sheet, it remains to be seen whether management will be receptive to its shareholders’ suggestions.
BackgroundHanesBrands is an American clothing company with a rich heritage dating back to its founding in 1901 as Hanes Hosiery. It operates in the global innerwear and activewear apparel categories. The company has a strong distribution network that reaches mass merchants, department stores, and consumers through both physical retail stores and e-commerce channels. HanesBrands also runs more than 200 physical retail outlets, further enhancing its presence and reach in the market.Hanesbrands has a history of delivering robust returns to its shareholders. In the 9 years from 2006-2015, total shareholder returns reached nearly 600%. 
However, share prices have fallen significantly over the past decade, down by nearly 90% from their peak of $34.14 in 2015.This underperformance can be attributed to both a combination of macroeconomic challenges within the apparel industry as well as strategic missteps made by the company itself.Breaking down its revenue by segment, a substantial portion of HanesBrands’ income comes from innerwear sales, accounting for approximately 83% of its total operating profits. The remaining operating profits are generated from international sales. It’s worth noting that the activewear segment has been facing profitability challenges, with negative profits reported in the most recent quarter. 
Some of HanesBrands’ peers include:
HanesBrands’ customer base skews more towards wholesale than retail. In 2022, their top 10 customers accounted for ~45% of total net sales. The top customer, Walmart, accounted for 16% of total net sales in 2022. Relying heavily on a small number of customers for a significant portion of total sales can expose the company to concentration risk. If any of these major customers were to reduce their orders or terminate their business relationship, it could have a substantial negative impact on Hanesbrands’ performance.
StrategyDuring a conference call with analysts in 2021, Steve Bratspies, the CEO of HanesBrands, launched a Full Potential plan to drive growth and profitability in the years ahead.Overall, the plan has four components:
Since Bratspies opened the curtain in May 2021, he has been focusing on core brands: Champion and Hanes. The strategic objective is to expand the global presence of the Champion brand, aiming to become a $3 billion brand by 2024. This growth plan centers on targeted expansion in key regions, including North America, China, Japan, South Korea, and the top five European markets.As part of the strategy, HanesBrands recently initiated a multi-year license agreement for the design, production, and distribution of outerwear under the Champion brand. 
The licensing agreement between HanesBrands and G-III enables to company to diversify its risk. As the president of Global Activewear, Vanessa LeFebvre, said, “G-III’s proven track record in category expansion and their best-in-class global infrastructure will enable us to reach a wider consumer base who already are, or will soon become, loyal to the Champion brand for generations.”The partnership is especially valuable in stabilizing HanesBrands’ performance when its core brand underperforms and international sales remain strong. In the second quarter of 2023, activewear sales declined 19% to $267.5 million. While Champion sales were down 25% in the U.S., international sales limited the overall sales decline to just 4% with an operating margin of 8%.Given the challenges that Champion has faced in the domestic market, it wouldn’t be surprising if HanesBrands decided to offload or sell Champion. Management has expressed that it is considering a potential sale, although shareholders have expressed skepticism in this regard. The recent decline in the company’s share prices reflects that investors are not keen about the prospects for a sale anytime soon.In fact, some shareholders are taking a more active stance by voicing their concerns about the sale of Champion. Barington Capital Group has built a small stake in Hanesbrands this year, and its CEO, James Mitarotonda, has conveyed concerns about the separation of the Champion business. In his own words, “Though the separation makes strategic sense, it is crucial that, despite the recent performance, the company achieves appropriate value for this iconic brand.”Under the proposed separation, HanesBrands would only retain the global innerwear business and other activewear segments with lower growth potential, which does not bode well for the company’s long-term prospects.
Potential CatalystsThe recent involvement of activist investor Barington Capital could eventually bolster Hanesbrands’ performance. In a letter to the board, Barington criticized Hanes’ strategy and indicated that it would support a change in leadership, at either the director or the executive level.More specifically, Barington laid out a plan for the company to reduce its inventory levels to free up cash and pay down debt. Their plan involves:
The company’s current inventory management practices present several risks which have weighed on results in recent years. For one, HanesBrands generally does not enter into purchase agreements that obligate customers to purchase products. This may lead to uncertainty in revenue generation, making the company vulnerable to fluctuations in demand and market conditions. As of December 31, 2022, HanesBrands’ inventory reached an all-time high of nearly $2.0 billion (176 inventory days), which is significantly higher than peers Under Armour (135 inventory days) and Gap (99 inventory days).Because the company has accumulated more inventory than expected, a substantial portion of this inventory has required write-downs or discounts. Reducing inventory days down to 170 could potentially release over $200 million in cash, which could then be applied to reduce the company’s expensive debt load.By optimizing their balance sheet and making leadership changes, Hanesbrands could also indicate to the market that it is actively trying to turn things around.
GovernanceStephen B. Bratspies, the current CEO, joined HanesBrands in 2020. Prior to joining the company, Bratspies held several positions at Walmart Inc., including as Executive Vice President, Food, and General Merchandise. Performance under Bratspies has been discouraging, as the company has lost approximately $2.6 billion (~59% of its market value) over the past three years. 
Bratspies’ compensation in 2021 and 2022 was heavily weighted towards stock and stock-option awards. Performance-based and at-risk compensation makes up 88.6% of total compensation. This alignment with shareholders is generally positive.However, the company decided not to provide incentive pay to its top five executives in 2022. It should be noted that HanesBrands has encountered significant challenges since then, with share prices declining ~74% since the start of 2022.
Financial AnalysisHanesBrands has shown a performance lag compared to its peer group, the Russell 2000, and the S&P 500 across various time frames spanning 1, 3, 5, 10, 15, and 17 years. Furthermore, HanesBrands’ shares have experienced a notable decline of 18% year-to-date. In contrast, the S&P 500 Retail index has increased by nearly 10% over the same period. These challenges are underscored by a negative net income margin and a relatively low return on total assets.
When comparing HanesBrands to its peers, certain financial metrics provide valuable insights into its positioning. HanesBrands boasts a moderate P/E ratio, reflecting investors’ willingness to pay a reasonable price for its earnings. It also stands out with the highest EV/sales ratio, indicating optimism about the company’s future revenue.Despite these encouraging ratios, various macroeconomic factors and industry dynamics exert influence. The rapid pace of fashion trends, driven by technology and changing consumer behaviors, challenges brands like HanesBrands to forecast and adapt swiftly. This dynamic landscape amplifies competition. Moreover, it’s important to note that while these ratios offer valuable perspectives on valuation and optimism, they do not directly illuminate the company’s debt situation. 
Zooming in on the latest annual balance sheet data, HanesBrands had current liabilities of $1.79 billion, with another $4.31 billion due beyond that. HanesBrands carries a debt-to-equity ratio of approximately 12x.In the apparel industry, a ratio exceeding 2.0 or 3.0 generally signals significant leverage, suggesting that the company has accumulated a substantial debt load relative to its equity. High debt service costs could jeopardize the company’s long-term financial sustainability, especially if the company has to roll over its debt at high interest rates in the coming years.
ConclusionThe outlook for HanesBrands is somewhat bleak, even if the company adheres to its own or its shareholders’ turnaround plans. The company’s valuation is not necessarily cheap when compared with peers, especially after taking into account the company’s weak operating performance and poor financial structure. My current view is bearish, given the absence of any material changes at the present time.More By This Author:Trian Strikes Back: Why Nelson Peltz Has Boosted His Stake In Disney
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