In 2021, I wrote how bankrupt Hertz (NASDAQ:HTZ) could become the top penny stock of the year. Shares of the $2 stock would eventually rise over 300% after a private capital bidding war sent shares of the car rental firm soaring.
My top penny stock pick for 2022 admittedly fared a bit worse. Prices of cannabis payments firm POSaBIT (OTCMKTS:POSAF) dropped 44% as investors pulled back bets on high-growth startups. (To be fair, my No. 2 pick Volt Information Sciences would offset the loss with a 103% gain).
As we all know, investing in low-priced stocks carries significant risks.
But 2023 is shaping up differently. As I outlined in my article 10 Stocks Under $10 for 2023, markets have sold off so badly that conservative and speculative stocks alike are now trading in the single digits. Even Under Armour (NYSE:UAA), a firm that generated $319 million in fiscal 2022 profits, trades at $10.
In other words, the market has become an all-you-can-eat buffet of safer stocks trading at historic discounts.
And I hope you’re hungry. Because my No. 1 stock for 2023 is a firm that investors will want to make room for.
My No. 1 stock for 2023: Hanesbrands (HBI)
At first glance, Hanesbrands (NYSE:HBI) is the opposite of a typical penny stock. The Winston-Salem-based firm has been around for over 110 years and generates around $500 million in profits per year from selling innerwear, socks, and Champion-brand apparel.
It’s a business that would send most speculative investors to sleep. Company sales have increased at a relatively steady 4.3% annual clip for the past decade, and Hanes has seen only one year of losses since 2001. When your primary business is producing underwear, there’s only so much excitement that can happen.
Nevertheless, 2022 has turned Hanesbrands into a penny stock. Shares bottomed out at $5.65 in December and still trade in the $7 range today.
To me, that spells opportunity.
Why HBI Stock Is the Top Value Play This Year
Before I make a full-throated recommendation for Hanesbrands, investors should be aware of three factors contributing to HBI’s low price.
First, the firm has around $1.4 billion of floating-rate debt on its balance sheet. For every 1% increase in rates, earnings decrease by over 10%. In November, these factors caused Moody’s to downgrade the firm’s outlook from “stable” to “negative.”
Second, Hanes has exposure to both commodity prices and exchange rates — both of which have negatively impacted results in 2022. Prices of cotton have fallen 31% in the past 12 months, while falling international currencies have shaved off 4% in dollar-based revenue.
And finally, a quirk of MSCI’s Global Industry Classification Standard (GICS) categorizes Hanesbrands as a “consumer discretionary” company rather than a “consumer staples” one. Shares thus typically trade closer to their cyclical benchmark, which tends to underperform badly during late-stage economic cycles.
That’s turned Hanesbrands into a stunningly cheap stock. Shares of HBI now trade at 7.4X forward price-to-earnings (P/E) and 0.39X price-to-sales (P/S), compared to their historic 10.6X and 0.8X ratios, respectively. A return to more “normal” valuations would suggest a 20%-25% return per year for the next five years.
The Catalyst for 2023
Hanesbrands, however, makes my No. 1 pick because these gains will likely happen all at once over the next 12-18 months. According to a long-term study by Fidelity Investments, consumer-based stocks tend to excel in early stage recoveries, rather than in mid- or late-stage economic cycles. Since 1962, the sector has outperformed the market 100% of the time in these earlier periods.
HBI follows this pattern to a tee. In 2009, shares of the apparel firm took less than 14 months to rebound from the financial crisis — rewarding investors with a 400% return in the process. And any investor who bought HBI in April 2020 would have enjoyed a 220% profit by May of the following year. It’s a sector investors need to buy early in the cycle.
From a fundamental level, there’s also a lot to like. Hanes’ strong brand name means customers pay a slight premium over No. 2 Fruit of the Loom and No. 3 Jockey. A 6-pack of men’s underwear from Walmart (NYSE:WMT), for instance, costs $10.98 for Hanes versus $10.48 for Fruit of the Loom. (These small differences do add up!).
Hanesbrands also plows back 1% of revenues into new product development. Activewear now generates around 40% of the company’s revenues, and products like Hanes Premium X-Temp underwear can sell for almost twice as much as regular items. (For the big spenders out there, a 3-pack of X-Temp boxer briefs retails for $18.48.)
Most importantly, consumers remain loyal to branded innerwear. According to a study by Euromonitor, 93% of men’s underwear and 98% of women’s ones are branded sales, with private-label making up the tiny sliver of the rest.
These factors mean Hanesbrands will likely generate returns on invested capital (perpetual money machine.) in the 20% range for at least a decade, making it an excellent example of a
What Is Hanesbrands Worth?
Predictable cash flows make companies like Hanesbrands natural candidates for discounted cash flow (DCF) modeling.
And the models don’t disappoint.
- Base Case. HBI’s base fair value comes in at $20 on a 3-stage DCF model. That assumes the firm’s credit rating remains at Ba2 and ROIC shrinks to the market average of 7.2% by 2043.
- Expected Case. The stock’s justified value rises to $28 if Hanesbrands’ credit rating improves to a Baa3 rating and ROIC remains above 10%.
- Bull Case. Fair value hits $47 if free cash flow returns to the pre-pandemic $700 million range and remains there through 2043.
Even discounting a permanent increase in interest rates by 2%, HBI’s expected-case valuation still remains around $22.4, a 215% upside from current levels.
It won’t be a smooth ride to the top, of course. Shares of HBI will likely trade sideways for the next several months until any recessionary fears abate in earnest.
But whenever markets do decide to pivot back to risk-taking, Hanesbrands will reap the benefits. Be sure you do, too.
On the date of publication, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.