Gildan Activewear Inc. (NYSE:GIL) Q2 2023 Earnings Call Transcript

Gildan Activewear Inc. (NYSE:GIL) Q2 2023 Earnings Call Transcript August 5, 2023

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2023 Gildan Activewear Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Jessy Hayem. Please go ahead.

Jessy Hayem: Good morning, everyone. Earlier, we issued a press release announcing our results for the second quarter of 2023. We also issued our interim shareholder report with the Canadian Securities and Regulatory Authorities and the US Securities Commission, which are available on our corporate website. Joining me on the call today are Glenn Chamandy, President and CEO of Gildan; Rhod Harries, our Executive Vice President and Chief Financial and Administrative Officer; and Chuck Ward, President, Sales, Marketing and Distribution. This morning, Rhod will take you through the results for the quarter and a question-and-answer session will follow. Before we begin, please take note that certain statements included in this conference call may constitute forward-looking statements which involve unknown and known risks, uncertainties and other factors, which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements.

We refer you to the company’s filings with the US Securities and Exchange Commission and Canadian Securities Regulatory Authorities. During this call, we will also discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable IFRS measures are provided in today’s earnings release as well as our MD&A. And now I’ll turn it over to Rhod.

Rhodri Harries: Thank you, Jessy. Good morning to all and thank you for joining us on the call today. This morning, we reported our second quarter results, which came in slightly ahead of our expectations [Technical Difficulty] top line and operating margin. We ended the quarter with $840 million in net sales with better-than-expected sales volumes in activewear, which offset weaker-than-expected product mix tied to current market conditions, which I’ll speak about a little later. During the quarter, we believe we outperformed the industry in a challenging environment, supported by positive activewear POS trends and the breadth of our product offering, which provided flexibility in what appears to be an increasingly more price-conscious environment.

This speaks to our strong competitive position and our ability to continue to drive market share gains. This said, while we continue to expect our revenues to grow year-over-year in the second half. We believe it is prudent to lower our outlook for the full year to reflect the impact of current market conditions on activewear mix as well as near-term uncertainty related to the broader macro environment. I will take you through the details of our revised 2023 outlook a little later, but first, I’d like to highlight that we remain fully committed to our capital allocation priorities having returned $175 million to shareholders year-to-date supported by strong free cash flow, which we continue to expect will exceed $425 million for the full year.

As such, with our existing NCIB program expiring, we announced this morning the renewal of our NCIB program to repurchase up to 5% of the company’s issued and outstanding common shares over the next 12 months. Now let me turn to the specifics of our second quarter results. Net sales for the second quarter came in at $840 million, down 6% year-over-year, reflecting a decline in activewear sales of 9%, partly offset by 8% growth in the hosiery and underwear category. In activewear, as previously communicated, we faced a strong comparative period as we cycled post-pandemic inventory replenishment. Overall, the year-over-year POS trend for the activewear category was positive during the quarter, driven by performance in North America, which improved sequentially, largely as anticipated.

On the other hand, international markets remain challenged with sales in the quarter down 2% versus the prior year, with POS trends softening sequentially, which fell below our expectations. Finally, good growth in the hosiery and underwear category for the quarter was mainly driven by underwear sales volume growth, reflecting the expansion of our private label offering and the rollout of new programs in the mass retail channel. Further, while industry demand for men’s underwear remained down year-over-year, it continues to improve sequentially, and we remain encouraged by the improving momentum for this product. Turning to margins. Adjusted gross margin came in at 25.8%, down 380 basis points year-over-year. This is largely a result of the anticipated flow-through impact on our cost of sales of peak fiber as well as unfavorable product mix in activewear related to shifting product preferences in this environment.

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SG&A expenses for the second quarter were $78 million, down $11 million versus last year mainly due to lower variable compensation expenses and our continued cost containment efforts, which more than offset the impact of cost inflation. As a percentage of sales, SG&A of 9.3% improved 70 basis points despite the impact of sales deleverage. Consequently, we generated operating income of 21.7% of sales during the quarter which included a net insurance gain of $74 million related to the two hurricanes that impacted the company’s operations in Central America back in 2020, partly offset by restructuring charges of $30 million, which include the closure of a sewing facility in Honduras. On an adjusted basis, operating margin of 16.5% was up 190 basis points sequentially, slightly better-than-expected but down 310 points compared to the prior year.

After reflecting net financial expenses of $21 million and factoring in continued share repurchases, we reported GAAP and adjusted diluted EPS for the quarter of $0.87 and $0.63 respectively. Moving onto cash flow and balance sheet items. Cash flow from operating activities was $182 million in the second quarter, which includes the net positive effect from the insurance gain mentioned earlier. This compares to $210 million in the prior year, and the drop is primarily due to higher working capital and lower net earnings. We continue to maintain healthy inventory levels, ensuring product availability and depth. Furthermore, we expect our inventory levels to decrease sequentially as was the case in Q2 and end the year below 2022 levels. After capital expenditures of $56 million, we generated approximately $126 million of free cash flow in the second quarter.

On the CapEx front, the progressive ramp-up of our new Bangladesh facilities is underway, which will continue through 2023 into 2024. We also bought back 2.6 million shares in the quarter, reflecting our strong commitment to return capital to shareholders. The company ended the second quarter of 2023 with net debt of $1.17 billion and a net debt-to-EBITDA leverage ratio of 1.8 times, in line with our 1 times to 2 times targeted debt levels. Moving onto the outlook for the full year. With strong comparative periods now behind us, we continue to expect our revenues to grow in the second half of the year, supported by the planned rollout of incremental retail programs. However, despite continued market share gains, we are seeing current market conditions negatively impact activewear product mix in both North American and international markets as customers focus on lower-priced products.

Combined with the near-term uncertainty related to the macro environment, we believe it is prudent to temper our previous full year 2023 expectations for revenue growth and operating margins, which now reflect the trade down occurring within our activewear product category. Finally, our full year 2023 outlook is also factoring in the impact of higher than previously expected financial charges for the second half. Accordingly, for 2023, we now expect revenue for the full year to be flat to down low single-digits versus the prior year. We also expect full year adjusted operating margin to be slightly below the low end of our 18% to 20% annual target range. Although this said, we continue to expect sequential quarterly improvement in operating margins through the second half of 2023.

We expect adjusted diluted EPS in the range of $2.55 to $2.65, including the impact of assumed share repurchase of 5% of our outstanding public float in 2023. And finally, we expect strong full year free cash flow generation above $425 million after capital expenditures, which we continue to expect to be at the lower end of our 6% to 8% target range. So in conclusion, while we faced some near-term headwinds driven by the macro environment, which we can see is driving customers to focus on lower-priced products and which has largely driven the change in our 2023 outlook, we are encouraged by our performance relative to our peers as we continue to gain market share in a difficult environment. Accordingly, we remain confident that as macro pressures subside, we will be positioned to fully capitalize on our market share gains and resume our growth trajectory.

This, combined with our cost structure that we believe is well under control in which we continue to improve positions us well as we work towards delivering on our financial targets and creating long-term shareholder value under the Gildan sustainable growth strategy focused on three key pillars of capacity-driven growth, innovation and ESG. Thank you and I will now turn the call back to Jessy.

Jessy Hayem: Thank you, Rhod. [Operator Instructions] Josephine, you may begin the Q&A session.

Operator: [Operator Instructions]

Jessy Hayem: Josephine, we’re ready to take questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Jay Sole. Your line is open.

Jay Sole: Great. Thank you so much. I’m wondering if you can elaborate on the current market conditions that you’re talking about that are unfavorably impacting the activewear. What exactly is going on? Is it sort of a customer issue? Is it a consumer issue? Can you — if you can elaborate that would be very helpful. Thank you.

Glenn Chamandy: I’ll start with that one. Look, I think, what we’re saying is that our market conditions are actually pretty strong ourselves. We’re gaining share in the market. The overall market, we think is down low double-digits in terms of activewear in the North American market. But obviously, we’re gaining share with a positive 2%. The real change and I think what we’re looking at is that the customers that are buying products are actually changing the type of product they’re buying. So they’re buying lesser-value type products. So for example, in instead of buying a hoody sweatshirt, they’re buying a crewneck sweatshirt, instead of buying some of the fringe items that we sell, they’re buying more basic items. And then one area we’re seeing is a shift back to basic product from the fashion product as the price points are lower.

So that’s really what’s happening. But the unit volumes are good. It’s just a shift in the mix of product, which is reflecting the actual net selling prices that we sell to these consumers, but our volumes are on track. Our volumes are good. We’re taking share in the market, although the market is weak and being challenged, that’s really what’s happened.

Jay Sole: Got it. And then Glenn, can you just talk about just the factory closure and maybe put it in context for us how that decision came about and sort of what the implications are?

Glenn Chamandy: Look, we’re — I wouldn’t take that factory closure as anything, but the continued optimization of our whole manufacturing supply chain and optimization in terms of really focusing on our Back to Basics. So it’s not a capacity-driven thing. We’re still running our capacity relatively at the same levels we were in Q1 and Q2 and where we are today. So we haven’t changed our capacity. We’re just continuing to optimize in these markets. I mean, we’re not running at full. Like what we said last time is we’re running between 85% and 90%. We’re still at those levels, but we’re constantly optimizing our structure, our cost structure and positioning ourselves to be low cost as we move forward into the future. So it’s more of a Back to Basics approach than anything.

Jay Sole: Okay. Thank you so much.

Operator: Your next question comes from the line of George Doumet of Scotiabank. Your line is open.

George Doumet: Yeah, thanks. Good morning, Glenn and Rhod. Glenn, I think last quarter, you mentioned we’re seeing pretty good yielded POS for fleece. I think you mentioned high single, low double. Can you just talk a little bit about how that’s been trending now?

Glenn Chamandy: Chuck will answer that.

Chuck Ward: Good morning. Yes, we’re still — fleece is still trending well. It’s not as strong as it was. I think the big thing that Glenn mentioned is sort of we’re seeing a mix change between hoods and crews, which the hood seller, a slight premium to the crew. So we’re seeing more of a mix shift, but fleece is still performing well.

Glenn Chamandy: And the mix shift is significant. Like just to put things in perspective, the price difference is in the neighborhood of 40% differential in price between a hood and a crew. So we’re selling the unit volume. The share is going up. We’re still in mid-single-digit type growth in fleece. But the thing is that the price point of the items from a crew to a hood is significant. It’s in the neighborhood of 40% difference between a crew and a hood. So they’re just buying a lesser-priced item, but we’re still selling the unit volume.