There's not much debate about the quality of the brands that Hanesbrands (NYSE:HBI) owns. Names like Hanes, Champion and Playtex resonate with consumers, and when it comes to innerwear, a large percentage of shoppers stick with a single brand for decades at a time. This company has not always managed to convert that brand value into shareholder value, though the stock has rebounded sharply from the lows of 2009. Now the question is whether management can not only maintain the value of these brands, but also wring more expenses out of the operations and deleverage the business.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Not Much Near-Term Momentum
While retail spending has started to perk up a bit recently, spending on clothing hasn't been smooth or even across the board. Particular retailers like American Eagle (NYSE:AEO) are doing better, but larger players like Walmart (NYSE:WMT), Target (NYSE:TGT) and Kohl's (NYSE:KSS) (which make up about half of Hanesbrands' sales) are seeing less robust growth. So while innerwear growth of 2.2% and overall sales growth of about 1% in the second quarter wasn't bad relative to Maidenform (NYSE:MFB) or Warnaco (NYSE:WRC), it's certainly not robust. Likewise, the four-point drop in gross margin and one-and-a-half point drop in operating margin aren't reasons for great excitement.

But Ample Scope for Improvements
I'm not all that bothered by Hanesbrands' quarterly performance, as this isn't the sort of stock where one quarter really changes the underlying thesis. That said, it does perhaps serve to reemphasize that the company's management needs to succeed with its ongoing improvement initiatives.

This past quarter's margins did not look great on a year-on-year basis, but that has to be viewed in the context of a "more than doubling" of the company's cotton costs (about 10% or so of COGS in normal times). While cotton prices have indeed come down substantially from last year's elevated levels, Hanesbrands processes those costs on a delayed schedule, meaning the company is going to start seeing the benefits of lower costs in the coming quarters.

But that's not all that the company can do. Hanesbrands' management should be able to wring nine figures of total cost savings through multi-year efforts to improve purchasing, optimizing the manufacturing/distribution chain and so on. Likewise, the company should be able to generate adequate free cash flow to start making a real dent in its leveraged balance sheet.

Rational Competitors, but a Shifting Retail Market
Various consumer surveys over the years have suggested that only about 10 to 30% of the innerwear market is really up for grabs, with the remainder pretty much devoted to one or two brands. That gives relatively little incentive to Hanesbrands and rivals like Warnaco, Maidenform and Berkshire Hathaway (which owns Fruit of the Loom, among other brands) to contemplate corporate murder-suicide with cutthroat pricing.

But that's not to say that Hanesbrands' business is steady as she goes. Retailers like J.C. Penney (NYSE:JCP) and Sears (Nasdaq:SHLD) are still trying to figure out a new retailing formula, and there's a lot of back-and-forth between mall-based retailers like J.C. Penney, discounters like Walmart and Target, warehouse clubs and "others" such as Kohl's. That offers up some challenges for promotion, merchandising and so on for Hanesbrands, but I don't think these will prove insurmountable.

The Bottom Line
This company has, in its past, reported pretty solid returns on capital and assets and solid margins. I believe that management is on its way back to doing so again. In my mind, the biggest risk to that goal is another sudden disruption to the cost structure (say, for instance, a bad cotton crop) or management going off-plan and making an expensive acquisition.

I'm a little concerned, however, that sell-side analysts have already raised the bar pretty high. I think it will be difficult (though not impossible or unthinkable) for the company to grow revenue much beyond a mid-single digit rate. While I think the company can get into the high-single digits with its free cash flow margin, I'm not sure it can go much beyond that. Accordingly, it's hard for me to see a fair value much beyond the high $30 range for these shares and that makes it difficult to recommend them as new buy.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  2. Stock Analysis

    The Biggest Risks of Investing in Amazon Stock

    Find out which risks are most important to Amazon's shareholders. Learn which operational risks impact share prices and which financial risks affect investors.
  3. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  4. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  5. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  6. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  7. Investing

    A Look at 6 Leading Female Value Investors

    In an industry still largely predominated by men, we look at 6 leading female value investors working today.
  8. Term

    What Is Financial Performance?

    Financial performance measures a firm’s ability to generate profits through the use of its assets.
  9. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  10. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  1. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  2. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  3. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  4. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  5. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  6. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!