We maintain our fair value estimate of $27 on narrow-moat Hanesbrands (HBI) and view shares as attractive. With the stock trading near multi-year lows, our fair value estimate suggests nearly 60% upside, trading at a P/E of just 9.4 versus our fair value estimate P/E of 15.6. Investors have cut Hanesbrands’ stock price in half over the past three years on concerns about its long-term debt (over $4 billion at the end of the second quarter) and sales weakness in some areas. While we acknowledge these issues, we argue Hanesbrands’ intangible brand assets provide a narrow moat. The firm has been innovative and some of its basic innerwear brands outsell competing brands by wide margins. It has successfully launched brand extensions in the usually staid market of underwear. Meanwhile, Hanesbrands has gained traction in the faster-growing activewear business. We believe its key Champion brand will grow worldwide sales by more than 40% over the next four years.
Investors may be focused on Hanesbrands’ short-term results and ignoring the potential for margin improvement. We estimate its overall adjusted operating margins will gradually improve from 13.8% in 2018 to 16.4% in 2027 due to profit gains in the activewear and international segments. We forecast both segments can reach 18.0% operating margins in 2024 as the firm integrates recent acquisitions and implements growth plans. Further, we expect a reduction in SG&A as a percentage of sales of approximately 200 basis points over the next few years from “Project Booster,” Hanesbrands’ companywide cost-cutting program.
Hanesbrands is in the process of paying down debt, but we believe its strong free cash flow will allow significant stock repurchase activity in the medium term. We forecast free cash flow generation of more than $3.5 billion over the next four years. We expect it will maintain a dividend payout ratio of about 30% and resume repurchase activity by 2020 after reducing its debt-to-EBITDA below three.
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David Swartz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.