Innerware manufacturer HanesBrands (NYSE:HBI) has to contend with fierce competition, powerful retailers, and a balance sheet that is far less than ideal. Although apparel manufacturing is going to remain a tough business for the foreseeable future and HanesBrands doesn't look cheap by conventional metrics, investors who look no further than the P/E or EV/EBITDA ratios may miss an interesting free cash flow expansion story in its early stages.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

A Tough Quarter
For a variety of reasons, HanesBrands delivered another poor quarter. Sales were slightly negative, as the company had to deal with retailers clearing out cold weather inventories, aggressive competition in graphic tees and some turbulence with Wal-Mart (NYSE:WMT). At the same time, higher cotton prices thumped margins (gross margin down more than a point) and operating income fell about 8%.

Bad Trends Easing Up?
On first blush, it would look like a fair number of the negative trends bedeviling HanesBrands should be lightening up soon. It looks like Berkshire Hathaway's (NYSE:BRK.A) has dropped its attempts to gain and hold share with aggressive pricing. At the same time, retailers like Kohl's (NYSE:KSS), Target (NYSE:TGT) and Wal-Mart have moved through the worst of their inventory corrections, and order patterns should begin normalizing relatively soon.

Considerably More Cash May Be Coming
One of the more under-appreciated positive angles on HanesBrands is the potential for significant near-term free cash flow leverage. Admittedly, HanesBrands' historic free cash flow production has not been great; better than Gildan (NYSE:GIL) and Warnaco (NYSE:WRC) perhaps, but below Maidenform (NYSE:MFB), and just not all that strong in an absolute sense at below 5%.

In the coming years, though, the company should be reaping the benefits of declining capex needs, as well as the benefits of past efforts to optimize its supply chain. All told, capex could drop by about 50% and represent just 40% of the spending of recent years. That will not only boost the free cash flow conversion into the very high single-digits, but it will also throw off cash that the company can use to pay off its excessive debt load.

The Bottom Line
Although brands like Hanes, Champion and Playtex are well-known and do inspire some brand loyalty, investors should not kid themselves about the quality of this company. HanesBrands is in a brutally competitive business where uncontrollable price inputs and powerful customers squeeze margins from both sides.

That said, management has made a lot of smart moves to improve operating performance, and metrics like return on capital are moving in the right direction. What's more, the free cash flow outlook for the next few years is about as good as it as ever been, and the momentum from that improvement could push these shares higher.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

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

Related Articles
  1. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  2. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  3. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
  4. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  5. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  6. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  7. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  10. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
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!