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Tickers in this Article: SLE, HBI, TGT, BRK.A, BRK.B
Corporate spinoffs have a history of outperforming the market, but apparel maker Hanesbrands (NYSE:HBI) so far has proved an unfortunate exception to the rule since being cast off by corporate parent Sara Lee (NYSE:SLE) in September 2006.

Overall market malaise has pushed the stock well below its initial trading price from two years ago and yesterday's third quarter earnings release didn't do much to help matters. Hanesbrands was hit by a number of special charges and higher commodity costs, but the long-term doesn't look as grim.

A Challenging Third Quarter
Third quarter sales barely budged, coming in at just under $1.2 billion. CEO Rich Noll cited strength in men's underwear, Playtex and active wear brand Champion, which grew by double digits. But hosiery and intimate apparel hosed Hanesbrands, with the former showing a 21.7% decline in sales, proving that these products are more economically sensitive than basic inner and outerwear, like t-shirts and underwear, which consumers tend to replace every couple of years as they wear out.

Margins were hit by higher cotton and oil-related manufacturing costs. In addition, Hanesbrands also took a 4 cents charge related to the bankruptcy of department store retailer Mervyn's, which was hit hard by the economic downturn and the excessive debt load it incurred when Target (NYSE:TGT) sold it to private equity groups a few years ago. The impact, which was pre-announced on October 24, also resulted in a sizable 35 cents restructuring charge for supply chain improvements and closure of nine manufacturing plants, as management shifts domestic production to Asia and the Caribbean. (Read the real story behind one-time charges at The One-Time Expense Warning.)

On a reported basis, earnings fell 58% to 17 cents per share. Excluding restructuring initiatives, however, earnings amounts to 56 cents per share, which surpasses analyst estimates. Hanesbrands does not provide quarterly or earnings guidance, but during the earnings conference call, management relayed that annual free cash flow generation is between $200 million and $300 million, which works out to $2.10 to $3.15 per diluted share.

A Company in Transition
Judging by overall sales trends, Hanesbrands is withstanding the economic downturn. But seeing as it just recently became an independent entity, the company must spend on right-sizing its supply chain and its plant mix during a period when consumers are cutting back on discretionary purchases. Also, Sara Lee saddled the company with billions of dollars in debt during the spinoff, which totaled $2.3 billion at quarter's end. (Find out more about assets and liabilities at Reading the Balance Sheet.)

Again, the majority of Hanesbrands' sales constitutes basic, necessary apparel, which makes the business model relatively stable. It is this stability that caused Warren Buffett's Berkshire Hathaway (NYSE:BRK-A, BRK-B) to acquire most of Fruit of the Loom's business operations out of bankruptcy in 2002. Interestingly, Fruit of the Loom declared itself bankrupt in late 1999 due to excessive debt and heavy spending to shift manufacturing facilities to more cost-effective overseas locales. (Explore how bankruptcy can lead to investment opportunities at Profit from Corporate Bankruptcy Proceedings.)

The Bottom Line
Fortunately, Hanesbrands is staying firmly in the black and plans on remaining cash-flow positive. In addition, Berkshire Hathaway's ownership of its chief rival confirms the appeal of the business model - when run correctly. Hanesbrands plans to continually pay down debt by $75 million to $125 million by the end of the year. Overall, barring any serious downturn in its business, earnings will benefit from moderating commodity costs, upcoming manufacturing efficiencies and reduced interest expense on lower debt. Given the potential upside, Hanesbrands remains a stock to keep on your shopping list.

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