S&P Global Ratings retained its debt rating on Hanesbrands and kept its outlook negative after the company presented its three-year growth plan amid an evolving outlook for the U.S. apparel industry, one year after the onset of the COVID-19 pandemic.
S&P said the company’s decision to exit the personal protective equipment (PPE) business it started in 2020 and discontinue its European innerwear business will reduce revenues by mid-single-digit percentages for 2021. However, growth thereafter is expected as it increases investments in marketing and manufacturing efficiencies.
The rating agency forecast credit metrics will rebound significantly in 2021 as Hanesbrands’ large restructuring charge in 2020 does not repeat and profitability normalizes. However, there is execution risk to its growth plan due to cost inflation and evolving consumer purchasing patterns post-pandemic.
As a result, S&P affirmed its ‘BB’ issuer credit rating on Hanesbrands, ‘BBB-‘ issue-level rating on its senior secured debt and ‘BB’ issue-level rating on its senior unsecured debt. The outlook remains negative.
S&P said in its analysis, “The negative outlook reflects the execution risk associated with Hanesbrands’ growth strategy, and the possibility leverage remains elevated in 2021 after rising significantly in 2020. The abrupt store closures and lockdown measures as a result of the pandemic sent a shock to apparel companies, which changed their product and channel mixes to minimize lost sales volumes. As a vertically integrated company, Hanesbrands turned to produce PPE to fill the demand created by the pandemic and keep its manufacturing facilities running. It added $820 million of PPE sales primarily in the second quarter of 2020 when most apparel companies suffered drastic declines. However, as the pandemic progressed, more competitors produced PPE, which saturated the market. Hanesbrands incurred a $374 million charge to write down inventories in the fourth quarter as growth prospects eroded. Additionally, Hanesbrands announced its Full Potential plan and incurred an additional $431 million of charges in the quarter. This resulted in low-double-digit leverage as we include most of these charges in our calculation of EBITDA.
“We now forecast EBITDA will start to normalize in 2021 toward 2019 levels, which should restore leverage below 4x. However, this will not rely solely on lapping the large costs incurred in 2020. As the company loses PPE and European innerwear sales in 2021, it must replace those sales with the continued growth of its revitalized Champion brand (low-double-digit percentage growth expected) and a rebound in its U.S. innerwear business that was declining in the low-single digits annually pre-pandemic. Hanesbrands posted strong revenue growth of 15% in the first quarter of 2021, continued growth will require additional marketing support, including planned incremental marketing spending of $50 million this year. However, government stimulus spending may have only temporarily lifted the first quarter, while rising inflation could reduce disposable income. This includes prices for fuel, food, and household products. Given these evolving economic risks, we would like to see continued progress toward credit metric restoration over the next few quarters.
“Hanesbrands’ plan for $300 million in growth capital investments and to double its marketing spending to increase revenues and market share would improve its overall product mix and manufacturing execution, but that could weaken credit measures if unsuccessful. Its scale and vertically integrated manufacturing have been competitive advantages as the company distributes to wholesale customers. Hanesbrands needs to adapt to changing consumer preferences for more on-trend apparel in younger generations who purchase online. To address this, Hanesbrands recently laid out a plan to segment its manufacturing so it can be more flexible to produce consumer-led innovations and supply the direct-to-consumer (DTC) channel to reach the younger demographic. Although not a complete manufacturing overhaul, it does involve significant capital for automation and increase capacity to reduce lead time and lower operating costs. It will also expand its U.S. West Coast fulfillment center to reach customers more efficiently. Speed to market is a competitive differentiator for the DTC channel and younger consumers.
“Additionally, Hanesbrands will raise its marketing spending to 4 percent of sales from 2 percent by 2024 to reinvest in its brands and make them more relevant with younger consumers. Its innerwear brands such as Hanes and Maidenform skew toward an older demographic. Hanesbrands believes there is a $1 billion revenue opportunity to capture in the under-39 generations. Moreover, we believe the company has recently revamped its Champion brand successfully. It forecasts that Champion will be a $3 billion global brand by 2024, expanding at a low double-digit percentage. Hanesbrands promoted Chief Digital Officer Cindy Miller, who will help build new data capabilities to work toward adding $1.2 billion of incremental revenue by 2024. Although we expect the company to self-fund these projects as it generates over $500 million of cash flow from operations, that still needs to be converted to higher sales to increase EBITDA and margins in line with our base-case expectations for a sustained high-teens percentage EBITDA margin. Moreover, Hanesbrands will require increased working capital, which could pressure free cash flow if sell-through is materially below expectations. In short, if these investments do not yield their targeted returns, leverage may not decline as we project.
“The casualization trend will continue to support Champion’s growth. The activewear segment led by Champion and Hanes has been the growth driver as innerwear, which accounts for about a third of total sales has declined the past few years due to the challenging U.S. retail environment, weak consumer traffic at retail locations, lean inventory management by wholesale partners, and retail store closures. We expect the casualization and health and fitness trends to continue to support growth for activewear even as consumers become more mobile outside of their homes as the pandemic lingers. Hanesbrands plans to invest in Champion and diversify its products into footwear, socks, and innerwear. It is allocating a significant portion of its investment budget to continue Champion’s growth trajectory toward a $3 billion brand.
“We don’t expect mergers and acquisitions (M&A) in the near term as the company’s capital allocation remains internally focused. Hanesbrands has a relatively new management team, also announcing new CFO Michael Dastugue in May. Management reiterated its financial goals to managing net leverage of 2x-to-3x. Given its current plan to spend on investments in the company, we do not expect M&A in the near term. According to management’s calculations, the company is currently leveraged at 3.1x and will repay debt until it reaches its target range. Once there, we expect share repurchases absent M&A opportunities. We do not expect Hanesbrands to raise debt to pursue M&A over the next 12-to-18 months and would view that as a shift in financial policy.
“The negative outlook indicates we could lower the ratings in the next 12 months if Hanesbrands does not execute its growth strategy to reduce leverage below 4x.”
Photo courtesy HanesBrands
