Steel City Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. During the third quarter of 2020, the fund returned 1.6% net of fees, while the S&P 500 Index was up 8.5%. You should check out Steel City Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Steel City Capital highlighted a few stocks and Hanesbrands Inc. (NYSE:HBI) is one of them. Hanesbrands Inc. (NYSE:HBI) is a clothing company. Year-to-date, Hanesbrands Inc. (NYSE:HBI) stock gained 17.9% and on October 27th it had a closing price of $17.50. Here is what Steel City Capital said:
“Hanesbrands (Short): HBI has been somewhat of a permanent fixture in the Partnership’s short book over the past two years. I have long believed that various aspects of the bull thesis – it’s cheap, everyone wears underwear, and Buffett owns Fruit of the Loom – are lazy and half-baked justifications for owning the stock. The investment proposition is substantially more nuanced and less attractive. Competition from private label offerings and new brand names have slowly been chipping away at HBI’s market share. The company is somewhat hamstrung in its ability to shift sales to the likes of Amazon given their heavy reliance on Wal-Mart and other brick-and-mortar retailers. Demand is anything but stable in downturns, a point illustrated by second quarter results. And lastly, HBI’s heavy reliance on company owned manufacturing facilities has embedded a high degree of operating leverage in the company’s cost structure.
It is this last point – operating leverage – that is perhaps most underappreciated by longs. Part of the company’s multiyear acquisition program has been predicated on consolidating manufacturing into existing facilities, thereby increasing their utilization and enabling HBI to better absorb fixed costs at the plants. Management has highlighted that approximately three fourths of the units it sells are manufactured at company facilities and they trumpet the mantra “volume up, unit costs down.” But this relationship works in reverse, too. Volume down, unit costs up.
During the second quarter, the company dodged a big bullet on this front. Sales came in at $1.74 billion, barely changed from $1.76 billion in the prior comparable period. Operating profit of $241.5 million was actually up 18.6% year-over-year. What happened? Revenue included a $752 million benefit from the sale of protective garments and facemasks (PPE). Absent the contribution from PPE, sales would have fallen 40%. Perhaps more instructive is the experience of HBI’s Activewear segment which did not book any PPE sales during the quarter. On a 52% revenue decline, segment operating profit fell more than 110%. Without PPE sales, operating profits would have been crushed across the board.
HBI’s outlook is considerably gloomier than 2Q’20 results suggest. Management noted the potential for a much reduced $150 million of PPE sales in the second half, U.S. apparel imports remain in negative territory, and back-toschool demand was hurt as educational institutions embraced distance learning. And while not issuing formal guidance, management noted, “While we continue to tightly manage SG&A expenses, the amount of temporary cost savings from the second quarter are currently not expected to repeat in the second half. Combined with a lower overall unit and sales volume, we believe it is reasonable to assume year-over-year pressure on margins in both this third and fourth quarters.” Volume down, unit costs up.
From a valuation perspective, shares are trading at 11.0x next years’ estimated earnings. At best, this is “in-line” with the five-year average of 10.2x, but it’s worth noting the long-term average is biased upwards by late 2015 figures which were influenced by considerably higher organic sales growth and non-fundamental demand for shares following HBI’s addition to the S&P 500. Viewed over a shorter three-year window, HBI has traded with an average multiple of 9.2x forward year earnings. At 11.0x – about one standard deviation above the three-year mean – shares are trading fairly rich. Such a valuation would be justified if the company were expecting improving organic sales growth and unit profitability, but there’s little reason to believe anything of the sort is right around the corner.”
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In Q2 2020, the number of bullish hedge fund positions on Hanesbrands Inc. (NYSE:HBI) stock decreased by about 14% from the previous quarter (see the chart here), so a number of other hedge fund managers don’t believe in Hanesbrands’s growth potential. Our calculations showed that Hanesbrands Inc. (NYSE:HBI) isn’t ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.
