S&P Global Ratings reduced the debt ratings on Hanesbrands, Inc. due to lower-than-expected sales and declining profitability. S&P also said Hanesbrands’ leverage increased to 6.7x as of July 1, 2023, from 4.2x last year as a result of recent results. The rating agency now expects leverage will remain above 5x over the next 12 months compared with its previous expectations of high-4x.
As a result, S&P lowered its issuer credit rating on Hanesbrands to ‘B+’ from ‘BB-‘.
At the same time, S&P lowered its issue-level rating on the company’s $900 million senior secured term loan B due in 2030 to ‘BB’ from ‘BB+’, with a ‘1’ recovery rating. Also, S&P lowered its ratings on the company’s unsecured notes to ‘B+’ from ‘BB-‘, with a ‘4’ recovery rating, indicating its expectation for average recovery (30 percent-50 percent, rounded estimate: 40 percent).
The negative outlook reflects the possibility of a downgrade due to S&P’s forecast for high leverage over the next 12 months and expectations for a tight covenant cushion.
S&P said in its analysis, “The downgrade reflects our view that tighter consumer spending and weakening apparel demand will continue to weigh on profitability, resulting in leverage staying above 5x over the next 12 months.
“Given results for the first half of 2023 and continued weakness in the consumer environment, we revised our base case downward and now expect leverage will be elevated over 5x longer than previously forecasted. The company recently reported second-quarter results that were below our expectations due to increasing challenges in the U.S. activewear market and Australia. Total revenue decreased 4.9 percent given a double-digit decline in activewear, including Champion brand, while S&P Global Ratings-adjusted EBITDA margin contracted about 470 basis points (bps) to 10.3 percent. Specifically, macroeconomic pressures from rising interest rates and general inflation come at a time of declining point-of-sale trends and excess retail inventory levels from previous supply chain constraints and retailer inventory realignment. Consequently, credit metrics have increasingly deteriorated over the past several quarters, with current leverage at 6.7x as of July 1, 2023, compared with 4.2x last year. In terms of leverage reduction, the company is on track to repay over $400 million of debt with free operating cash flow (FOCF) and reduce inventory to about $1.5 billion by the end of the year. Roughly $100 million of debt has already been repaid year to date, and inventory units are down by double digits as of the second quarter. We view the inventory and debt reduction positively given the immediate benefits to key credit metrics and potential interest expense savings. Though we believe leverage can improve from current levels because the company plans to use FOCF to repay debt and will lap elevated freight and input costs in the second half of 2023, our expectation for lower sales this year will constrain profitability in the near term. As such, we forecast leverage to elevate above 5x in 2023 and into the first half of 2024.
“We expect a meaningful turnaround in the Champion brand will take time as the company focuses on reducing excess inventory and repaying debt this year.
“Global Champion brand sales have sequentially declined in the high-teens percent area since the start of 2023 given an industry-wide decline in the activewear category, its pricing strategy across channels, and its over-reliance on the value channel in the U.S. Notably, the company has recently brought new leadership to the brand, removed unproductive product through stock-keeping unit rationalization, and identified growth opportunities in U.S. and international distribution. While Champion remains a driver for long-term growth ($3 billion brand sales target by 2026), we believe it will take time for new innovations to successfully come to market and for specific brand challenges to be remedied.
“We believe management remains committed to achieving its long-term financial targets, but we acknowledge recent shareholder activism will heighten scrutiny on the company’s near-term performance.
“Since extending its long-term growth plan to 2026 earlier this year, the company has not made any changes to its $8 billion sales and 14.4 percent operating margin targets. Management remains committed to reducing its leverage to its financial policy target of 2x to 3x and has committed to using all FOCFs for debt repayment. Hanesbrands also cut its dividend in early 2023, as part of a refinancing and covenant relief amendment. We acknowledge Barington Capital’s recent activist campaign, which will likely heighten scrutiny on management decisions and could result in changes if it acquires a meaningful stake in Hanesbrands. Currently, Barington Capital owns less than 5 percent of the company’s stock.
“The negative outlook reflects the possibility of a downgrade due to our forecast for high leverage over the next 12 months and expectations for tight covenant cushion.”
Photo courtesy Champion
