Let’s talk about underwear.
There are many ways this particular type of clothing has been gussied up, but in the end, it’s really just a commodity.
Hanesbrands (NYSE:HBI) thus finds itself in a difficult position. Apparel companies make for highly volatile stocks because consumer tastes are fickle. Certain types of apparel might be considered a consumer staple, but there’s a fine line between consumer staple and commodity, and I fear Hanes sells the latter.
It offers T-shirts, bras, panties, men’s and kids’ underwear, casual wear, active wear, shape wear, socks, and hosiery products, primarily under the Hanes, Champion, Bali, Playtex, Just My Size, L’eggs, barely there, Wonderbra, Gear for Sports, Stedman, Zorba, Rinbros, Sol y Oro, Outer Banks and Duofold brands. It sells through retailers and third-party “embellishers” as well as through 216 direct outlet stores.
Thus, it sells commodities with no barrier to entry, and products that rely on the cost of cotton — a commodity that causes unpredictable fluctuations in pricing. When cotton prices tripled, Hanes had to raise prices 20%.
The result is a company that has a heavy debt load, high interest payments and weak cash flow. Hanes has little cash on hand — $35 million — and that’s offset by $1.94 billion in long-term debt. The company ran negative operating cash flow of $94 million in the most recent quarter, only $77 million in free cash flow in 2011 and $27 million of FCF in 2010.
But it’s the debt that’s really hurting Hanes — it paid $156 million in interest, or about 11%, in 2011.
On the bright side, the company is projecting a huge turnaround for free cash flow this year. Management plans to pay off the expensive debt later this year, which should bring total debt down to $1 billion.
I wouldn’t count Hanes out just yet. For now, the stock trades at 12x earnings, with FY12 earnings expected to drop compared with last year, rebound 22% next year and settle in at 8% growth going forward.
I think that’s too expensive to be gambling on. I would sell shares if you hold them and wait to see how the turnaround goes.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
