In the past, volatile cotton prices and recession induced drops in consumer spending have adversely affected the apparel industry. However, increasing population and rising disposable income growth are once again reviving the consumer spending pattern as the U.S. economy has targeted to bring unemployment down to 7% by the end of 2013. This will boost the industry’s revenue in the upcoming years. Recently, Hanesbrands Inc. (NYSE:HBI) acquired Maidenform Brands, Inc. (NYSE:MFB) in order to enhance its product portfolio and increase its market presence.
The reason behind paying 30% premium
The acquisition of Maidenform Brands, Inc. (NYSE:MFB) was very compelling as the company is a strong strategic fit into the core business of Hanesbrands Inc. (NYSE:HBI). It complements the Hanesbrands Inc. (NYSE:HBI)’ Innovate-to-Elevate strategy. Hanesbrands Inc. (NYSE:HBI) looks forward to achieving higher growth along with production cost cuts, derived from the larger scale of operations resulting from this deal.
The two companies operating together will enhance the efficiency of operations as previously Maidenform Brands, Inc. (NYSE:MFB) was buying all its products from outside manufacturers which will now be manufactured by Hanesbrands Inc. (NYSE:HBI). Hanesbrands Inc. (NYSE:HBI) will be utilizing its low cost supply chain to maximize the value of Maidenform to retailers and consumers.
The purchase of this company will enhance the product portfolio by adding shape wear and completing the bra range offered by Hanes. Currently, Hanes has a strong market position in the panty business. This grouping offers substantial long term growth prospects to Hanes by merging the relative strong points and potential capabilities of the two portfolios and cross introducing new products.
This deal is forecasted to deliver all expected synergies in the next three years, adding more than $500 million in sales and $80 million in operating profit. The incremental earning per share is estimated to be $0.60 per year. Pure value addition for shareholders will be $0.65 cash flow per share, an increase of nearly 100% on an annual basis.
The company will be utilizing cash available on hand and borrowings on its revolving credit facility. The new borrowing agreement will reduce its finance cost by 25 basis points and raise its borrowing limit to $1.1 billion. Hanes expects to repay its debt from the company’s free cash flow. Currently, Hanes’ long term debt to EBITDA has risen to 4.39 times. However, the company expects to maintain this ratio within the range of 1.5 – 2.5 times in the long run.
However, the announcement of this definitive agreement by Hanes has instigated scrutiny of the proposed acquisition of Maidenform by a number of law firms in the country. The investigation is focused on the possible breach of the fiduciary duty by the board of directors of Maidenform and aims to provide maximum value to the investors. If the case is proven right, then Hanes may be forced to pay a higher price for this acquisition, which would reduce the net synergies realized. However, it will benefit the shareholders of Maidenform.
The market position of competitors
Despite the headwinds, the company has maintained strong margins with a five year annual growth rate of 6.5% in gross margins. The company focuses on four pillars for growth: increasing sales of existing stores, opening up new stores, using e-commerce and franchising to achieve its fourth pillar of international expansion. Express, Inc. (NYSE:EXPR) increases existing store productivity through deeper selection of fashion essentials, improved pricing, more effective marketing and introduction of new categories to boost sales. E-commerce sales as a percentage of total sales have grown from 5% in 2007 to 12.6% in 2012. This increase was achieved through optimizing digital marketing, improving analytics and operations and driving sales through new capabilities.
Conclusion
The acquisition is expected to result in substantial value creation for the retailers, customers and shareholders of Hanes. It is also currently undervalued with a P/E (ttm) of 18.9 compared to the industry average of 25.6. The company does not have a history of paying out dividends and tends to provide return to its investors only in the form of price increase only. In my opinion, the stock is an immediate buy for a term of minimum three years.
Express is currently in its growth phase. The company is yet to cover many untapped markets. With its rigorous strategies to widen its product range and expand geographically within the U.S. and abroad, the company is expected to register higher returns in the future as well. Express also provides return to its investors in the form of price appreciation. I would advise buying this stock.
The article Is Hanesbrands Emerging As a Stronger Company? originally appeared on Fool.com and is written by Awais Iqbal.
Awais Iqbal has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Awais is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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