Updated HBI Report

The Knall-Cohen Fund 1

Key Statistics

Investment Thesis In the midst of turbulence and uncertainty in the markets, Hanesbrands makes for a solid bellwether distinctly well

positioned to take advantage of broad emerging industry trends.

Hanesbrands’ dominant Innerwear segment sustains stable sales and margins, while the growing, well-positioned Activewear

segment provides the Company exposure to a strong industry trend towards “Athleisure”

Improved operating margins and synergies from recent acquisitions will give Free Cash Flows a ~13% annual boost over

the next 3-5 years

Hanesbrands’ International segment has significant room for growth in multiple regions

Industry leading ROIC of 16.7% and ROE of 42.3%

Investment Risks Ideal acquisition targets may not come up over the next few years, resulting in considerably lower sales growth rates

Expectations for cost synergies may have been too optimistic

Target, Wal-Mart or Kohl’s make major unexpected shifts in strategy which reduce overall purchases from Hanesbrands

specifically

Negative exchange rate pressures continue to depress earnings from the International segment

Business Overview Hanesbrands operates in the apparel, footwear, and accessories industry of the consumer discretionary sector. Hanes sells bras,

panties, shapewear, hosiery, underwear, socks, t-shirts, and other activewear through the Americas, Asia, Australia, and Europe.

Because they are the number one brand of total apparel in the U.S. and are found in 8 out of 10 U.S. households, they function

as a hybrid of a consumer staple and consumer discretionary company.

Hanesbrands Inc. (T- $27.62)

Recommendation: Buy Price Target: $32.50

Sector: Consumer Discretionary Industry: Apparel

Analyst Names: Samarth Dua

Neil Shah

Phone Number: (408) 876-0020

(224) 944-1957

Date: February 25th, 2016

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Source: Bloomberg


Table of Contents Industry Overview ....................................................................................................................................................................... 3

Consumer Discretionary Environment & Themes ..................................................................................................................... 3

Apparel Industry Environment & Themes ................................................................................................................................. 4

Business Overview ...................................................................................................................................................................... 6

Segments ................................................................................................................................................................................... 7

Geographic Distribution ............................................................................................................................................................ 8

Major Customers ....................................................................................................................................................................... 9

Innovate-to-Elevate ................................................................................................................................................................... 10

Acquisitive Strategy................................................................................................................................................................... 11

Financials ................................................................................................................................................................................... 12

ROIC and ROE ....................................................................................................................................................................... 12

Revenue and Margin Assumptions ........................................................................................................................................... 12

Free Cash Flow ........................................................................................................................................................................ 13

Appendices ................................................................................................................................................................................ 14

HBI DCF ................................................................................................................................................................................ 14

HBI Comps ............................................................................................................................................................................. 15

Revenue and Income Models ................................................................................................................................................... 16

Balance Sheet ........................................................................................................................................................................... 17

Common Size Balance Sheet .................................................................................................................................................... 18


Industry Overview Hanesbrands operates in the Apparel industry, a part of the Consumer Discretionary sector. Globally, publicly

traded consumer discretionary companies are valued at a total of $13.65 trillion. Publicly traded apparel, footwear, and

accessories companies are valued at a total of $1.2 trillion.

Consumer Discretionary Environment & Themes The Consumer Discretionary sector represents 13.1% of the S&P 500 by market cap weighting (as of December

2015). This sector is highly correlated and very sensitive to changes in consumption trends, macroeconomic conditions,

and consumer confidence. Over the last year, the S&P 500 Consumer Discretionary Index (returning -1.98%) has

outperformed the S&P 500 (returning -8.77%) by around 6.79%. Year-to-Date, the Consumer Discretionary Index (-

3.56%) has outperformed the S&P 500 (-4.11%) by 0.55%.

The overall environment for Consumer Discretionary has been recovering. The sector is driven by discretionary

spending by the average consumer, so as the financial condition of the individual consumer improves, the outlook for

Consumer Discretionary stocks improve. Most indicators as of the last couple years have been signaling a healthier

recovery for consumers than in the 5+ years prior. Unemployment rates nationwide are sitting at 5%, job creation is

averaging above 200,000 per month, and wage growth is picking up steam (0.5% increase in January 2016). Most of these

indicators are being followed closely primarily for their implications regarding the Federal Reserve and its decisions on

interest rate hikes, but they more directly point to an improvement in conditions for discretionary consumer spending.

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Index Performance

S&P 500 Index BI Global Branded Apparel Peer Group S&P 500 Consumer Discretionary

Source: Bloomberg


Low Gas Prices

Arguably the most influential theme for

the Consumer Discretionary sector over the last

year and a half has been the freefall in retail

gasoline prices. An average American consumer

buys a little over 1000 gallons of gasoline a year.

With gas prices now down near $1.80 (as

opposed to a $3.55 average for the 3 years prior),

this amounts to around $1750 extra in the

pockets of the average consumer. This increased

discretionary income is largely expected to come

as a windfall for the consumer discretionary

sector overall, and by and large, it has. JP

Morgan Chase Institute analyzed 25 million

credit and debit card user accounts (anonymously), and their findings demonstrated that consumers had been spending

almost 80% of their gas savings. The most popular categories for increased spending were clothing, restaurants, and

entertainment.

These findings do stray from those of a somewhat prominent Visa report in May 2015. There are 2 possible

reasons for this: (1) Visa’s report was based on self-reported data, so consumers may have biased responses towards

increased savings, and/or (2) Visa’s research was conducted soon after retail gas prices started falling, so consumers may

have decided to increase spending only after seeing relatively consistent low gas prices.

Apparel Industry Environment & Themes The apparel industry has been facing a less promising short-term environment than the overall consumer

discretionary sector, and this has been reflected in the industry’s performance over the last year (see “Index Performance”

pg. 2). Although low commodity prices (especially for cotton and petroleum) are helping improve gross margins, stronger

headwinds like an unexpectedly warm winter and a very strong dollar are counteracting them.

Longer term, however, industry conditions are improving. Tailwinds, including the aforementioned windfall of

gasoline savings and cheaper distribution methods, will have positive impacts on sales and margins. Furthermore, an

internal shift between apparel companies is likely to become more pronounced, as the “athleisure” trend gains further

traction.

Warm Weather

The 2015-2016 winter season has been particularly warm, with daily temperature highs and averages 10-20

degrees higher than historical averages throughout the Midwest and East Coast. This is having a pronounced impact on

many apparel companies as most are dependent on higher margin cold-weather apparel to feed their bottom lines. VF

Corp. is a good example; some of its most profitable and successful brands (Timberland, The North Face, Nautica) make

most of their sales in the winter season.

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U.S. Weekly Retail Gasoline Prices

Source: St. Louis FRED


The main reason for this warm weather is the butterfly effect of El Nino (associated with the periodic warming

of the Pacific Ocean). The jet stream has been forced further north than usual, bringing milder weather to the Midwest

and Northeast and more snowfall to areas like Denver. The impact of El Nino is expected to abate in the next few years;

however climate change is causing more extreme swings in weather patterns around the world, suggesting more

unseasonably warm weather in the decades ahead. This may not bode well for the longer term outlook on apparel

companies highly dependent on winter sales.

Exchange Rate Pressures

Unfavorable exchange rates

have also been negatively impacting

sales for American apparel

companies, many of which derive a

significant portion of their sales

from outside the US. Nike and VF

Corp, which together account for

over 50% of the apparel industry by

market capitalization, made only

44.8% and 61.7% (respectively) of

their sales from North America. The

impact of a strong dollar is

particularly pronounced for these

companies.

Although the USD Index

rose 9.3% over the course of 2015, and is up 3% YoY, a weaker dollar doesn’t appear to be particularly close on the

horizon. Most major international markets are weakening their own currencies (i.e. the EU, Japan, China, and various

Southeast Asian countries), while the US is instead looking to raise rates.

One of the partially offsetting factors of a stronger dollar is a decrease in the cost of imported goods and

commodities. Many apparel companies benefit in this manner, seeing as significant amounts of materials are sourced

from Southeast Asia.

Athleisure

Athleisure is a relatively recent trend within apparel. It began to take form as gym apparel became more acceptable

outside the gym, especially as athletic wear such as yoga pants, gym shorts, and sweats became more casual and accessible

in non-athletic environments. The market for athleisure wear is growing quickly – according to the NPD Group,

athleisure sales came out to over $35 billion in 2014 (8% growth YoY), and in 2015, athleisure composed almost 17% of

the overall American clothing market. This subset of the apparel industry is gaining traction especially well among

millennials.

The companies at the forefront of the athleisure trend are Nike, Under Armour, Lululemon, and Hanesbrands.

Under Armour and Nike are more on the active side of athleisure (the “athl-”). Lululemon has performed especially well

with casual athleisure (the “-leisure”), particularly in women’s categories. Over the last couple years, most other apparel

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USD Index

Source: Bloomberg


companies have thrown their hat into the ring. American Apparel, Dick’s Sporting Goods, and Urban Outfitters are

among the many new entrants into athleisure.

Growth of Direct-to-Consumer

In recent years, the Direct-to-Consumer (DTC) distribution model (particularly in terms of e-commerce) has

become much more appealing for the apparel industry. Shipping (via UPS, USPS, and FedEx) has reached a sufficiently

developed stage, and online selling platforms are now established and proven. Apparel producers can develop their own

site, or utilize one of the multiple established marketplaces (among which Amazon is the biggest and most obvious

choice).

Online shopping has also become a preferred option among consumers. According to Adobe, online sales over

the Thanksgiving and Black Friday shopping weekend increased 18% to $4.47 billion. Mobile shopping accounted for

$1.5 billion of sales. Amazon did represent the lion’s share of online purchasing during this period, however Target and

Walmart both also benefitted from significantly increased traffic on their own respective online properties.

Online DTC appears to be a growing long-term trend with strong implications for apparel producers. This

distribution channel allows a greater extent of control over pricing and product sales. In addition, by removing a

(previously necessitated) major intermediary step altogether, apparel producers have the opportunity to develop better

inventory management and feedback systems. The quicker inventory turnover could also significantly diminish the

potential impact of unexpected changes in weather cycles. Overall, we see the increased shift by apparel producers to

online DTC distribution channels being a positive impact mostly on margins.

Business Overview Hanesbrands is an outlier in its industry. Where most competitors are focused on newer, more enticing trends in

apparel, Hanesbrands is centered on the basics & stability. Where most competitors experience explosive growth rates

(see Nike and Under Armour), Hanesbrands climbs steadily. Where most competitors have developed geographic

diversity, over 80% of Hanesbrands’ sales are from the United States.

All of this is by design. Hanesbrands’ strategy is straightforward and somewhat plain, yet successful. Maintain a

collection of top brands with demonstrated staying power, control a centralized yet cost effective supply chain, and only

pursue long term, underlying trends. Hanesbrands supports this strategy by buying brands that fit into its existing

structure and overarching business goals (specifically, stable cash flows), and extracting all possible cost synergies as they

integrate the acquired company into their business.

The result: Hanesbrands isn’t as exposed to the major headwinds of warm weather impacts and exchange rate

pressures battering other high-quality apparel companies, yet is still well-positioned to be able to take advantage of some

of the best opportunities for long term growth going forward (namely, Athleisure and Direct-to-Consumer distribution

channels). In addition, its financial metrics are also promising. Hanesbrands makes an industry-leading RoE of over 50%,

RoIC of 16.8%, and has an Interest Coverage Ratio of 7.3 (relevant due to a comparably higher leverage).


Segments Hanesbrands is divided into 4 operating segments; Innerwear, Activewear, International, and Direct-to-

Consumer. The Innerwear and Activewear segments are product development and production units, and are primarily

involved in the preparation of apparel to be sold. The International and Direct-to-Consumer segments are distribution

units, and are primarily engaged in the sale of apparel produced by the Innerwear and Activewear segments.

Innerwear

Hanesbrands Innerwear is the largest segment in the company. It accounts

for over 50% of sales. Innerwear is split into Intimates, which includes bras and

hosiery, and Basics, which includes men’s underwear, socks, panties, shapewear,

and kid’s underwear. Key brands in the Innerwear division are Hanes,

Maidenform, Bali, Playtex, and Wonderbra. Each brand is among the top 2 in

their product category.

The Innerwear segment is a source of stable growth. As a general apparel

category, innerwear is much less exposed to wide swings in demand; almost

everything in this category is a replenishment product, so sales are generally fairly

steady. This also means that unseasonably warm weather is not as significant of a

concern; sales of socks will decrease slightly, but overall the segment will not be

impacted by a noticeable margin.

Activewear

The Activewear segment accounts for over 25% of sales. It manufactures and sells retail activewear and collegiate

apparel. Activewear has been one of the early beneficiaries of the athleisure trend, and continued growth is expected.

This segment should help Hanesbrands invest in millennials as customers, because of the popularity of athleisure among

their demographic.

Basics71%

Intimates29%

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Sales by Segment

Innerwear Activewear International DTC

Source: Hanesbrands


Hanesbrands is maintaining a fashion-risk averse position in retail activewear. It isn’t going head to head with

companies like Lululemon, instead choosing to pursue a more everyday take on athleisure (as opposed to Lululemon’s

more fashion-oriented approach). Hanesbrands key brands for retail activewear are Champion, C9, and Hanes.

Knights Apparel, which was acquired in early 2015, operated in the collegiate apparel space. It will be integrated

with Gear for Sports, Hanesbrands pre-existing collegiate apparel line, as a complementary secondary distribution

channel for selling products.

International

The International distribution segment is accounting for an increasing share of revenues as Hanesbrands looks

to develop geographic diversification to a greater degree. In 2015, the International segment was responsible for 20% of

total sales, a 42% growth rate YoY, after currency impacts. In the last two years, the International segment has been

bolstered by the DBApparel (now known as Hanes Europe Innerwear) as it’s quickly been integrated into the

Hanesbrands business. However, even after integrating DBApparel, and the International segment bringing in a greater

share of total revenues, Hanesbrands still has lower exposure to

exchange rates than many of its direct competitors.

Direct-to-Consumer

The Direct-to-Consumer distribution

segment usually accounts for around 7-9% of sales.

40% are from online sales, while the rest are from

Hanesbrands own outlet locations. The Direct-to-

Consumer business has a well-established online

platform, with an Amazon “storefront” as well as

Hanesbrands’ own independent website.

Although it is highly unlikely that

Hanesbrands will need to, or want to shift a

considerable amount of distribution volume from

its current retailer-oriented model to a primarily

online and Direct-to-Consumer approach, the

development of expertise in the field should help

Hanesbrands in the case that it finds retailers to

become a less effective sales medium than historically demonstrated.

Geographic Distribution On the demand side, Hanesbrands is very geographically concentrated. 85% of sales are from the US. Within the

International segment, however, Europe has become Hanesbrands’ biggest market (aided by the DBApparel acquisition

in 2014, see “Acquisitive Strategy”). Because of this, Hanesbrands is most exposed to the USD-EUR exchange rate on

the demand and sales side. A weak Euro has had a currency translation impact on Europe sales (which account for 12.5%

of total sales).

Hanes “storefront” on Amazon


On the supply side, almost all of Hanesbrands

supply chain and self-owned manufacturing operations

are located in Latin America (specifically Honduras, El

Salvador, the Dominican Republic and Haiti) and

Southeast/East Asia (specifically Vietnam, Thailand,

and China). The currency environment in most of these

countries is similarly dovish (encouraging weakening of

the currency) to that of Europe. Because of weaker

currencies in countries from which materials and

products are usually sourced, in addition to low

commodity prices, Cost of Goods Sold will likely be

reduced and margins slightly higher.

Major Customers Although Hanesbrands has its own distribution

channels, it is still very dependent on large retailers to

resell products. Their top 10 customers comprise 56%

of net sales, and their 3 largest customers (Wal-Mart,

Target, and Kohl’s) account for 43% of net sales. This dependence goes both ways – Hanesbrands is among the largest

apparel suppliers for each of its top three customers.

Because of the high level of interdependence between

the Company and its top customers, Hanesbrands

knows a substantial element of pricing and seasonal

promotions by the beginning of the year; especially so

for its Innerwear business.

The Company’s heavy reliance on retailers

comes with risks, however. If any major customer

changes its strategy significantly or suddenly, there is a

high chance that Hanesbrands will be impacted. Take,

for example, Target Corporation’s recent decision to

wind down Target Canada. Although sales at

Hanesbrands’ International segment grew by 42% in

2015, this increase was offset by “the exit of a significant

retailer in Canada,” as cited in the 2015 10-K. Again, this

risk is offset by significant sales and pricing foresight

afforded to the Company by its customers. Nonetheless,

a relevant vulnerability exists.

Wal-Mart23%

Target15%

Kohl's5%

Other Top 1013%

Smaller customers

44%

Hanesbrands Largest Customers

Source: Hanesbrands Inc. 10-K

Japan11%

Canada9%

Mexico6%

Brazil3%

China0%

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Other8%

Europe63%

International Sales by Region

Source: Hanesbrands Inc. 10-K


Innovate-to-Elevate Innovate-to-Elevate (I2E) is Hanesbrands’ branded corporate strategy. It refers to the combination of 3 elements:

1. Brand Power

2. Innovative Platforms

3. Supply Chain Leverage

Hanesbrands emphasizes the strength of brands and

maintaining a powerful brand image with each product line.

Within the apparel industry, and especially so in Hanesbrands’

specific subindustries, branding is incredibly pertinent to

driving sales. According to research by the NPD Group (and separately, the Company itself), a brand is the #1 decision

driver for customers when it comes to innerwear and general apparel purchases. Branding outranks comfort, fit, style

and price, so it’s particularly important for Hanesbrands to acquire and maintain the best lineup.

In that respect, Hanesbrands has executed well on maintaining and improving its brands. It has the #1 brand (by

market share) in Male Underwear, Intimate Apparel, Socks, and Hosiery. It has the #2 and #3 spot in multiple other

apparel categories it participates in. Hanes, Champion, Bali and Playtex are all either #1 or #2 in their respective product

groups. In addition, over 80% of US households own at least one Hanesbrands product.

Innovative Platforms refers to apparel solutions and innovations that can be applied

across brands relatively easily. In addition, many allow for more optimal sales pricing while

minimally increasing costs to produce. Current platforms include X-Temp, ComfortFlex,

and ComfortBlend. X-Temp is a sweat-wicking, cooling underwear for men designed to

increase comfort for the customer. ComfortFlex is a flexible, size-adjusting bra that (1)

allows for a more comfortable fit, and (2) dramatically reduces the number of sizes that

need to be offered. By reducing the number of sizes, Hanesbrands saves due to less items

needing to be stocked, and less varieties needing to be manufactured. In addition,

Hanesbrands is able to charge a higher price point.

Supply Chain Leverage is most applicable for newly acquired companies and

brands. When integrating the new brand into Hanesbrands, the Company moves most manufacturing operations to their

own facilities or to their own dedicated suppliers because of the strength of their supply chain network. Hanesbrands

maintains control over almost all of its manufacturing; over 85% of all apparel units produced are made by either

Hanesbrands itself, or by their own dedicated suppliers.

A major consideration for Hanesbrands (since they prefer to produce in-house) is input commodities; of these,

cotton and petroleum are the most important. The cost of cotton accounts for 7% of total Cost of Goods Sold. If cotton

prices move up 1¢ per pound, Hanesbrands Cost of Goods Sold will increase by $4 million. To deal with this,

Hanesbrands hedges their prices in times where cotton is cheap. The risk of long term commodity price inflation still

stands, though.

Hanesbrands has demonstrated an ability to properly manage high-quality brands and improve them – it generally

maintains slightly over a 3% organic growth rate with the aforementioned I2E strategy. Additional strategic acquisitions

help Hanesbrands bolster its businesses and build sales volume faster.

ComfortFlex sizing chart


Acquisitive Strategy Hanesbrands has completed many accretive, strategic acquisitions since being spun off from Sara Lee. Its M&A

activity is primarily focused on adding brands and integrating them into the operations and structure of Hanesbrands,

and then extracting cost synergies. Within 1-3 years, the acquired companies are normally (fully) integrated, and start

counting towards organic growth. Hanesbrands almost always pays fully in cash, and generally raises debt to finance the

acquisition. This is the reason behind the relatively high leverage ratio.

A major risk for Hanesbrands is that cost synergies are not what the Company expected. This would result in an

additional debt burden, and an

The general acquisition criteria are:

The Target should fit in one of Hanesbrands’ core categories

Complementary revenue growth opportunities are present in consumer segments, channels, or geographies

The purchase must be financially justifiable based on highly probable cost synergies

The purchase should provide strong returns to shareholders and be accretive in the first year

Knights Apparel

Hanesbrands acquired Knights Apparel in early 2015 for $200 million. Knights Apparel was purchased at an 8x

2015 EBITDA multiple; the Company expects to achieve a 4.5x EBITDA after synergies are fully realized. Sales for 2015

were $160 million. Estimates for operating profits and operating cash flows going forward are $40 million (for both).

Synergies are expected to be fully realized by 2017-2018.

Knights Apparel was involved in the collegiate apparel subindustry, and primarily sold through mass retail chains.

Gear for Sports, Hanesbrands’ preexisting collegiate apparel division, primary sells through college bookstores. This

acquisition is expected to help both companies cross sell products, and to help Knights’ achieve better operating margins

by manufacturing through Hanesbrands’ supply chain.

Hanes Europe Innerwear (DBApparel)

DBApparel was acquired in mid-2014 for $550 million, approximately 7.5x EBITDA. Synergies are expected to

be fully realized by 2017-2018. Post-synergies, Hanesbrands expects Hanes Europe Innerwear to contribute $875 million

in net sales and $125 million in operating profit on an annual basis, with a post-synergy multiple of less than 4x EBITDA.

DBApparel had a very similar operating structure to Hanesbrands, except that it outsourced the production of

most products in its intimate apparel and underwear segment. The acquisition of DBA by Hanesbrands significantly

increased sales in Hanesbrands’ International segment, and over two years DBA has helped more than double

International revenues.

The cost synergies from using Hanesbrands’ manufacturing facilities and dedicated suppliers will help DBA

increase its margins and reduce costs of goods sold, while increased income and cash flows will help expand the business

and its market share in Europe.


Financials

ROIC and ROE ROIC and ROE have been particularly

strong for Hanesbrands historically. ROE

has consistently been above 20% since the

Company began operating, and has

averaged around 30-40%. We believe the

company will be able to maintain higher

levels of ROE, because of extra cash being

used for stock buybacks. In addition, equity

hasn’t been diluted noticeably since the

company began operating.

Revenue and Margin

Assumptions We see revenues continuing their

consistent upward trend. Based on our

projections of revenue growth per segment,

2016 should be a year of sluggish growth

due to significant short term headwinds.

The years afterward should see a return to

overall revenue growth ranging around 7-

15%. The International segment has room

to expand in Europe, and barely tapped

markets in Brazil, Australia, and Japan. The

Activewear segment should see consistent,

8-12% growth as the Athleisure trend snowballs,

and Innerwear should maintain its steady growth

around 2-4%. Lastly, we expect accretive

acquisitions supporting the steady organic growth

of each individual segment. Considering most of

the apparel industry has experienced heavy selloffs

in stock prices, we see some attractive acquisition

targets becoming cheap enough for Hanesbrands to

consider looking at.

Gross margins should continue increasing,

albeit at slower rates, as Hanesbrands continues to

improve cost controls.

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ROIC and ROE

ROIC ROE

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Gross Margins


Free Cash Flow From 2012 to 2014, free cash flows

were consistently above $400 million, as net

income grew at a reasonably consistent pace.

In 2015, one-time items had a significant

negative impact on free cash flow, but the top

and bottom lines continued to grow at

appropriate rates. We believe 2016 will see

significant revenue headwinds in the form of

heavy currency exchange rate pressures and

warm weather impacts to carry over through

the year. However, we also see revenue

continuing at high-single-digit to low-teens

growth rates in the years after. In addition, we see accretive acquisitions continuing to support steady organic growth

rates. Gross margins should continue increasing, due to continuing improvements of cost controls, albeit at a slower

rate.

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Free Cash Flow


Appendices

HBI DCF


HBI Comps


Revenue and Income Models


Balance Sheet


Common Size Balance Sheet

Updated HBI Report

Documents

Transcript of Updated HBI Report