Gildan Activewear Inc. (NYSE:GIL) Q3 2023 Earnings Call Transcript

Gildan Activewear Inc. (NYSE:GIL) Q3 2023 Earnings Call Transcript November 2, 2023

Gildan Activewear Inc. beats earnings expectations. Reported EPS is $0.74, expectations were $0.72.

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2023 Gildan Activewear Earnings Conference Call. Please be advised that today’s conference call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Jessy Hayem, Vice President, Head of Investor Relations. Please go ahead.

Jessy Hayem: Good morning, everyone. Earlier, we issued a press release announcing our results for the third quarter of 2023. We also issued our interim shareholder report with the Canadian Securities and Regulatory Authorities and the U.S. 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.

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We refer you to the company’s filings with the U.S. 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.

Rhod Harries: Thank you, Jessy. Good morning all and thank you for joining us today. This morning, we reported our third quarter results, which unfolded largely in line with our expectations. We resumed our sales growth trajectory and delivered operating margin, which is back within our target range, a testament to the fact that our competitive position remains very strong even in a challenging environment driven by our industry-leading vertically integrated manufacturing platform and our continuous focus on optimizing our operations. So we ended the quarter with net sales of $870 million, up 2% year-over-year, and operating margins of 18.1% with GAAP EPS and adjusted EPS of $0.73 and $0.74 respectively. We generated operating income of $305 million and free cash flow of $265 million, which allowed us to be active on our capital allocation priorities or more specifically our share buyback program where we have repurchased over 3.5% of our float year-to-date through the end of the third quarter.

As communicated in today’s press release, we are updating our guidance for revenues and EPS which are now expected to be at the lower end of our previously communicated ranges. I’ll provide more details on our guidance a little further but more importantly, I will also provide details on why we remain confident in our ability to maintain growth momentum and strong operating margins as we move through this uncertain environment towards 2024 and beyond. Now let me turn to our third quarter results. Net sales for the third quarter came in at $870 million, up 2% with Activewear sales essentially flat at $744 million while hosiery and underwear sales were up 16%. Looking at Activewear, there are several puts and takes to highlight. Firstly, we benefited from healthy POS levels for Activewear overall, particularly in fleece and ring-spun products.

In fact, we benefited from strong fleece shipments which were driven by both double-digit sell-through trends and seasonal replenishment. Now within fleece, we did see some of the trade-down we had described in Q2, but all in all it was a strong quarter for our fleece category. We also saw strong shipments of ring-spun products as we continued to grow share in this category. Elsewhere, we did see some offsetting factors in Activewear with lower shipments of basic T-shirts and the unfavorable impact of some targeted price actions in certain channels, although overall the pricing environment remains relatively stable. Finally, international markets performed well below our expectations with sales down 23% during the quarter due to lower demand and price pressures across all international markets.

Turning to the hosiery and underwear category, this was a bright spot for the quarter and we saw increasing momentum and good sell-through data. In particular, we are excited with the rollout of our new and expanded underwear programs in the mass retail channel, which are driving market share gains. Further, in hosiery, we continue to see strong demand for our products, thus overall a solid quarter for the hosiery and underwear category despite ongoing industry-wide weakness. So on the whole, and despite the challenging environment, we are pleased with the sales performance we were able to deliver in the quarter as travel, tourism, large events and the everyday use and replenishment nature of our products continue to drive underlying demand.

Turning to margins. Gross margin came in at 27.5% of sales in the third quarter, down 220 basis points versus the prior year. As anticipated, the lower gross margin was primarily driven by higher raw material and manufacturing input costs as well as slightly lower net selling prices. However, as expected, we saw a sequential improvement of 170 basis points to our gross margin from Q2 to Q3 as pressure stemming from the flow-through of peak cotton costs in the first half of 2023 abated. This will continue to be a tailwind for us as we move through Q4 and, importantly, as we move into 2024. Turning to SG&A, expenses for the third quarter were $82 million and were flat year-over-year. As a percentage of sales, SG&A was down 20 basis points to 9.5%, primarily driven by the benefit of sales leverage.

Looking at our SG&A performance so far this year, we continue to be pleased with how the team is managing SG&A in this difficult inflationary environment and we expect this performance to continue as we move forward. Consequently, summing up these elements for the third quarter, we generated operating margin of 17.8% of sales and adjusted operating margin of 18.1% of sales, putting us back within our target 18% to 20% range. And 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 $0.73 and $0.74 respectively. Moving on to cash flow and balance sheet items. Cash flow from operating activities totaled $305 million versus $66 million in the prior year, mainly due to significantly lower working capital investments this quarter, which included the impact of working towards ending 2023 with healthy but low 2022 inventory levels.

Furthermore, after capital expenditures of $43 million in the third quarter, we generated $265 million of free cash flow, compared to the use of $7 million in the prior year. On the CapEx front, the progressive ramp-up of our new Bangladesh facility is underway, which will continue through 2023 and into 2024, and we continue to expect an exit capacity rate around 25% at the end of 2023. Finally, we ended the quarter with net debt of $1 billion and a net debt to EBITDA leverage ratio of 1.6 times, well within our 1 to 2 times targeted debt levels. Now turning to the outlook for the full year. We continue to expect year-over-year revenue growth in the fourth quarter as we cycle an easier comparative period and benefit from the full rollout of our new retail programs.

However, even though POS trends have progressively improved through 2023 across both our Activewear and hosiery and underwear categories, and trends remain in positive territory into Q4, we are seeing some softness in certain markets stemming from the macro environment. As such, we are tilting our guidance towards the lower end of previously provided ranges for revenue and EPS. Accordingly, for 2023, we now expect revenue for the full year to be down low single digits versus the prior year. This compares to prior guidance of revenues being flat to down low single digits. There is no change to our full year adjusted operating margin guidance, which is expected to be slightly below the low end of our current 18% to 20% annual target range. We now expect adjusted diluted EPS to be at the low end of the previously provided range of $2.55 to $2.65, including the impact of assumed share repurchases of 5% of our outstanding public float in 2023.

And again, we continue to expect strong full year free cash flow generation above $425 million after capital expenditures, which are expected to be at the lower end of our 6% to 8% target range, so no change to these metrics or to our attention to remain active on share buybacks as we finish the year and head into 2024. So in closing, and as we head toward the end of the year, I would like to leave you with a few thoughts. 2023 has been characterized by normalizing inventory and replenishment patterns following the multi-year volatility related to the pandemic. But unfortunately, we are seeing end user behavior impacted by inflationary pressures and uncertain macroeconomic conditions. Consequently, while our year-to-date top-line growth is not where we originally hoped it would be when we started the year, we have demonstrated again how our company can remain resilient, agile, and financially strong in any environment.

Further, we are incredibly excited with the opportunities that lie ahead. Despite the tough environment, we have resumed our growth trajectory and we are making great strides in our GSG strategy, accelerating the pace of product innovation, optimizing our manufacturing platform to strengthen our competitive cost structure, and progressing on our ESG targets, all of which support our long term growth opportunities which remain intact. Furthermore, we remain encouraged by market share gains in key categories and our strong margins and cash flow generation and our overall balance sheet strength, which are allowing us to deliver on our capital allocation priorities. Our focus on the long term vision for our company and on creating value for our stakeholders remains unwavering and we thank you for interest and support in Gildan.

This concludes my formal remarks. And with that I’ll turn it back over to Jessy.

Jessy Hayem: Thank you, Rhod. Before moving to the Q&A session, I ask you to limit the number of questions to two and will circle back for a second round of questions if time permits. Desiree, you may begin the Q&A session.

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Q&A Session

Operator: Thank you. The floor is now open for your questions. [Operator Instructions] We’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Paul Lejuez with Citigroup. Your line is open.

Paul Lejuez: Hi, thanks guys. Can you talk a little bit more about the international markets where you saw weakness? Any more specifics on where that was? What categories? And I’m curious if that is what’s driving the change towards the low end of the range? And then specifically, how did your outlook change, if at all, within the U.S. market within each of your two segments? Thanks.

Rhod Harries: I’ll just handle the – what’s driven the change to the low end of the guidance and I’ll turn it over to Chuck to give a view on what’s going on in the markets. But if you do look at what we’ve said on the guidance, yes, the answer is international did play into that. So if we look at the fourth quarter and what we’re seeing, we do still see good growth. So I would say probably the best way to think about it is mid single digit growth for Q4. We will get the benefits of the retail programs. We are seeing the market share gains. We do have the easier comps. But then we have to be a little cautious as we look at the market on a go forward basis driven by some softness that we are seeing in certain areas. And international is playing into that very definitely.

We are also being careful on pricing as well, I think, as we go into the fourth quarter and that is really in international when we look at it. So we do see lower prices than international. We see some pockets somewhere around different markets. But overall, actually, pricing is staying relatively stable as we finish up the year and as we move into 2024. But international is playing into it and I will turn it over to Chuck to give you some color.

Chuck Ward: Thank you, Rhod. Good morning and I guess we will start first with Q3 and the international question. I mean, overall, as we look at internationally and I’m going to break it down Europe and Asia as we think about Europe, we were up low single digits from a POS perspective, but we did see de-stocking during the quarter. It continues to be a challenging market in Europe. Obviously, there is current geopolitical and economic environment challenges, but the fundamentals of the market we think are still there and we are starting to see the POS come back but we did see de-stocking during Q3. And we are seeing sequential improvement as we go into Q4. Asia also was down high single digits, low double digits as well. And again, I think that’s on inflationary pressure.

Now, as we think about Q4, as Rhod mentioned, and we think about internationally, we are seeing improvement in the POS, but we think it will be a – continue to be a challenging market. We’re also seeing some challenges, obviously, in national accounts that service large retailers. As they also face sort of the macroeconomic conditions that we see and that’s the way we’re looking into Q4.

Paul Lejuez: And then specifically in the U.S. business, what changed there in terms of your outlook?

Rhod Harries: If you look at the U.S. business, actually the U.S. business is holding up pretty well, Paul, as we go into the fourth quarter. As we said, we see positive POS from an Activewear perspective. We see positive POS in underwear and hosiery. So, we feel very good about that. Really, we know we’re taking share and we know that the programs that we’re focusing on are doing very well in the marketplace. So, overall, the U.S. is holding up. Now, we are seeing probably a little bit more de-stocking in the fourth quarter than we had anticipated. If you look at the third quarter, we did see some de-stocking. We saw in basics, it wasn’t quite as much as we anticipated. But as we go into the fourth quarter, we will probably see some catch up on that and we will see a little bit more de-stocking.

So, those are the things that we are thinking about from a U.S. perspective. But overall, I would say, we are very, very pleased with how we are performing in this market because we can see our market share is growing. And effectively, we are very well positioned in all of the different channels that we are selling to.

Paul Lejuez: Thank you. Good luck.

Operator: Next question comes from the line of Chris Li with Desjardins. Your line is open.

Chris Li: Hi. Good morning, everyone. Maybe just a follow-up question on the POS trend, in particular in the U.S. for Activewear. I remember last quarter you mentioned that in July it was up mid-single digits. Is it possible to provide some guidance around – color in terms of how that trended in August and September and then also how that is trending so far in Q4? Thank you.

Glenn Chamandy: Chris, it’s Glenn. I will look into to your – to Rhod’s point. I mean our POS overall in Activewear is running mid-single digits positive. So we’re really in Q3 similar to what we discussed with you in our last conference call. So, we really basically for the full quarter finished around mid-single digits. And that was driven by double-digit fleece and ring-spun growth. And the overall market particularly in our distributor channel was probably down double digits, so we are taking share. And I think that’s really the point is that we’re really performing well in a really tough environment. So we are on all four cylinders and we are pretty excited about our share momentum. And one of the things I think is important for us in this type of environment is to focus on what we can control.

So we’re focusing on taking share. Our availabilities are great. We’re doing quite well in all of our product categories. We’re focusing on our operating margins where we can see that the margin improvement in Q3 will continue to improve as we move into Q4 as we discussed. Our costs are under control and we have very good visibility as we move into Q4. We had really great cash flow and that’s another big focus for the company as to continue driving strong cash flow and continue to buy back shares like we have seen the 5% and maybe we will be in a position even to buy back more as we move into the latter half of the year. And despite the environment, we are reinvesting in low cost – in developing our low cost positioning with continued investments in Bangladesh as well as investments in our yarn-spinning operations which we’re focusing on – really focusing on value and innovation.

So we have got a lot of innovation that we are going to bring to the market in 2024 and we think we’re going to enhance our value proposition. And we’re working on supporting new programs as well. So all these things together, I mean the market conditions are weak, but more importantly as we’re focusing on what we can control and just making sure that we stick to our knitting and deliver strong operating results for Q4 and as we move into 2024.

Chris Li: Great. That’s very helpful. Thank you, Glenn. And maybe my second question is switching gears to the tax rate. There seems to be a potential for a 15% global minimum tax potentially for next year. I just want to get maybe your latest thoughts around that. And if it does happen, what are some of the ways that Gildan can offset some of the impact? Thank you.

Rhod Harries: Hi, Chris. This is a topical question. There is a lot of focus on global minimum tax. We are closely monitoring developments to assess the impact as we go forward. I think as you look at global minimum tax, you have to take a look at and understand the specific implementation details that are occurring in the various countries, including the countries where we operate. And we are monitoring the impact of other incentive programs, which are under review in certain jurisdictions around the world, which are effectively being put in place to support investment and local activity. So as we go forward here, I think we’ll get more clarification, more clarity on that as we move into the fourth quarter. And we have to look at all of this together to be able to assess the impact for 2024 and beyond.