Apparel firm HanesBrands (NYSE:HBI) reported third quarter results on Wednesday that saw continued solid sales growth, and another quarter of impressive profit expansion. Combined with a reasonable earnings multiple, the stock is worth a look, though the investment story does have one major potential drawback.
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Third Quarter Recap
Sales improved 4.8% to $1.2 billion. HanesBrands divides its operations into five primary units, and reported low double-digit growth in both the outerwear (t-shirts and fleeces) and international segments. Innerwear (underwear and socks) eked out 0.5% growth while direct-to-consumer (outlet stores and online) sales fell nearly 3%. Hosiery (L'eggs, Hanes brands) sales were the laggard, falling almost 8%.

Operating profits advanced nearly 34% to $152.7 million, as innerwear and outerwear posted profit increases of more than 40%. Direct-to-consumer profits grew a robust 16.5%, with international and hosiery posting profit declines. Management attributed the overall profit growth to a higher-margin sales mix, price increases and cost controls, the last of which continues to benefit from supply-chain efficiencies implemented since being spun off from former parent Sara Lee (NYSE:SLE). (For related reading on operating profits, see Understanding The Income Statement.)

Interest expense grew only 5.3%, but still ate up more than a quarter of operating income and stems from a hefty debt load inherited as part of the spinoff. Overall though, the modest growth helped push net income up 48.1% to $90.8 million, though diluted earnings grew a slightly slower 44.4% to 91 cents per diluted share due to higher shares outstanding.

Outlook
Analysts currently project full year sales growth of 14%, and total sales of nearly $5 billion. HanesBrands tempered its full-year earnings guidance range to $2.75 to $2.85 per diluted share, though this will still represent year-over-year growth of "more than 25%." It also gave a free cash flow range of $100 million to $200 million, which would represent a pretty wide range between $1 and $2 per diluted share.

The Bottom Line
HanesBrands plans to use free cash flow to pay down its hefty debt load of $2 billion. Sales have proven very resilient throughout the economic downturn and management has managed to steadily boost profits, but has been aggressive in spending on capital expenditures and making acquisitions. As such, it has had to continually rely on outside debt financing to fund its operations and roll over existing debt.

This strategy could prove very risky, if credit markets return to experiencing volatility as they did in 2008. And, though unlikely, it would be nice to see management more aggressively reduce debt and more conservatively balance its growth ambitions. Customer concentration is another drawback, with four firms, including Wal-Mart (NYSE:WMT) and CVS Caremark (NYSE:CVS), each accounting for more than 10% of sales in many of the operating units.

Despite these concerns, the recent sales growth and profit improvements have been impressive. Additionally, HanesBrands' valuation is quite reasonable with a forward P/E of about 10. The free cash flow multiple would also be quite reasonable, if management can end up generating cash flow toward the higher end of its wide range. Combined with reduced debt, HanesBrands could end up like the handbag firm Coach (NYSE:COH) as another extremely successful spinoff from Sara Lee. (For related reading on the forward P/E, see How To Use The P/E Ratio And PEG To Tell A Stock's Future.)

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At the time of writing Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

Tickers in this Article: HBI, SLE, WMT, CVS, COH

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