Hanesbrands: As Dividends Fall, Debt Reduction Takes Front Stage

Investment Thesis

Hanesbrands Inc. (NYSE:HBI) is a consumer goods company that designs, makes, sources, and sells basic clothing for men, women, and children. The once mighty maker of basic and active wear struggles to stay afloat. As 2022 concluded, the corporation reported weak financial results as revenues and margins declined. Sales at Hanesbrands fell 16% year over year in the fourth quarter. A portion of the issue is the slump in American consumer spending, but retailers are also lowering their inventories. This indicates fewer replenishment orders have been placed, which has more than offset recent price hikes at Hanesbrands.

Due to lower sales, higher input costs, and expenses related to a manufacturing time-out, the operating margin decreased in each segment. The corporation reported a sizable net loss due to a sizable charge linked to deferred tax assets. As a result of this dismal showing, the corporation is preparing for a challenging year in which debt reduction will take precedence. The company’s management has implemented stringent efforts to cut down on the debt accumulated recently. Management has resorted to cutting off all dividend payments and redirecting cash flow to debt servicing to reduce debt.

Shares of HBI fell more than 27% after the clothing manufacturer announced it was eliminating its dividend and instead planning to use its free cash flows to reduce its debt load. Investors will likely be upset by this choice resulting in a mass exodus, and the stock price may fall further, but I think it’s the best course of action at present, and the long-term gains could be great for those who are patient.

The Debt Crisis and Its Correlative Variables

As of December 2022, Hanesbrands stock had $3.86 billion in debt, up from $3.35 billion a year prior. The company has a net debt of $3.62 billion but cash of $238.4 million.

A closer look at the most recent balance sheet information shows that Hanesbrands owed $1.79b within the next 12 months and $4.31b beyond that. It had $238.4m in cash and $721.4m in accounts receivable due within a year. The company is in the red as its obligations exceed its cash and short-term receivables by $5.15b. In this case, the shortfall significantly impacts the $1.89b company’s overall value. I believe investors should keep a careful eye on this. After all, if Hanesbrands had to pay its creditors today, a significant re-capitalization would be necessary.

Hanesbrands has a lot of debt, as evidenced by its net debt to EBITDA ratio of 5.2. The good news is that it has a respectable interest cover of 3.7 times, indicating that it can afford to meet its financial commitments responsibly. Yet over the past year, Hanesbrands has seen its EBIT plummet 35%. Paying down that debt will be highly challenging if income trends in that direction.

Consideration should be given to the extent to which this EBIT is supported by free cash flow. During the past three years, Hanesbrands only generated 17% of their EBIT in relation to free cash flow. To me, a low cash conversion rate raises some doubts about its debt-eradication prospects.

I’m concerned about Hanesbrands’ debt levels because of its slow EBIT growth rate and its history of failing to keep up with its overall liabilities. Its inability to turn EBIT into free cash flow further diminishes confidence. Considering everything I’ve discussed, I believe Hanesbrands is overextended financially. Hence, it seems to me that investing in this stock currently could be fraught with danger. To prevent the situation from spiraling out of control, it was necessary to make some tough decisions.

Decisions Going Forward: Managing The Debt

Hanesbrands has been working on cutting down on its inventory, and in terms of units, it has been successful. At the end of 2022, the company had 6% less inventory than it did at the beginning of the year. But the total value of that inventory was still 25% higher than the year before because costs went up. In the first half of 2023, Hanesbrands expects to be able to free up working capital and drive cash flow as it sells off its more expensive inventory. For the entire year, the business anticipates an operational cash flow of roughly $500 million. Getting rid of these costly items will also help increase margins in the year’s second half. Hanesbrands believes that when the company leaves 2023, its gross and operating margins will be “significantly higher.”

To get to that point, though, Hanesbrands must be thrifty. As a result, the company decided to forego paying dividends so that the money might be put toward paying down debt. By the end of the year, Hanesbrands had racked up $157 million in interest payments on its $3.6 billion in long-term debt. Rising interest rates will exacerbate the difficulty of repaying such debt. Interest expenses are expected to grow due to Hanesbrands’ first-quarter plan to refinance its debt maturing in 2024.

In What A Predicament Their Debt Placed Them

After Hanesbrands, Inc. posted fiscal 2022 results below expectations and suspended its annual dividend to prioritize debt repayment, S&P Global Ratings and Moody’s Investors Service downgraded its debt ratings.

Moody Downgrading:

The corporate family rating (CFR) for Hanesbrands Inc. was lowered to Ba3 from Ba2, the probability of default rating (PDR) was lowered to Ba3-PD from Ba2-PD, the senior unsecured rating was lowered to B1 from Ba3, and the senior unsecured rating of the Hanesbrands Finance Luxembourg S.C.A entity (“HF Lux”) was lowered to Ba3 from Ba2. There has been no change to the SGL-3 speculative grade liquidity rating. The forecast is still grim.

Moody’s also assigned Ba2 ratings to the company’s proposed $750 million senior secured term loan B (“TLB”), the current $1.0 billion revolving credit facility, and the existing $975 million term loan A. The planned $750 million term loan B will partially refinance Hanesbrands’ $1.43 billion (FX-adjusted) senior unsecured bonds that mature in 2Q’2024.

S&P Downgrading:

Hanesbrands had its issuer credit rating lowered by S&P to BB- from BB. The proposed $750M senior secured term loan B due in 2030 was given a ‘BB+’ issue-level rating, and a ‘1’ recovery grade by S&P. S&P downgraded the company’s 3.50% euro-denominated unsecured notes to BB- from BB, with a recovery rating of 3, and its 4.8750% and 4.6250% senior unsecured notes to BB- from BB, with a recovery rating of 4. A downgrade from S&P is possible in the coming year if the company fails to keep debt below 5x and make progress toward positive free operating cash flow, both of which are reflected in the gloomy outlook.

These downgrades and the potential for additional downgrades are evidence of the company’s precarious debt condition, which, in my opinion, requires swift and complex action to handle. This justifies, in my opinion, temporarily suspending dividend payments to direct cash flows toward debt service.

The Bottom Line

Dividends paid out by Hanesbrands in 2022 were $209 million, a sizeable sum that may now be applied to paying down the company’s debt. Hanesbrands plans to pay off its debt with the entirety of its cash flow. Eliminating the dividend is never good, but if the company can weather the current economic storm, brighter times are likely ahead. By 2026, Hanesbrands hopes to have an annual revenue of $8 billion with an operating margin of 14.4%. Despite falling demand, the company still makes a profit after adjusting for expenses. The worst cost inflation that drove up manufacturing prices is now cooling. Hanesbrands stock is a comeback tale worth exploring for patient investors ready to forgo dividends.