Hanesbrands, Inc.’s debt ratings were lowered by S&P Global Ratings and Moody’s Investors Service after the parent of Hanes and Champion reported fiscal 2022 results below expectations and the suspension of its annual dividend to prioritize debt repayment.
Moody’s downgraded Hanesbrands Inc.’s corporate family rating (CFR) to Ba3 from Ba2, probability of default rating (PDR) to Ba3-PD from Ba2-PD, senior unsecured rating to B1 from Ba3 and the Hanesbrands Finance Luxembourg S.C.A entity’s (“HF Lux”) senior unsecured rating to Ba3 from Ba2. The speculative grade liquidity rating (SGL) remains SGL-3. The outlook remains negative.
At the same time, Moody’s assigned Ba2 ratings to the company’s proposed $750 million senior secured term loan B (“TLB’), the existing $1.0 billion revolving credit facility and the existing $975 million senior secured term loan A. Proceeds from the proposed $750 million term loan B will be used to refinance, in part, indebtedness under Hanesbrands’ existing $1.43 billion (FX-adjusted) of senior unsecured bonds that mature in 2Q’2024.
Moody’s wrote, “The downgrade of the CFR to Ba3 reflects Moody’s expectation that Hanesbrands’ earnings will remain constrained in 2023 following a weak fiscal 2022. Hanesbrands has suffered from an industrywide pullback in inventory purchases from large retailers, a dynamic that is exacerbated by the company’s material customer concentration. For fiscal year ended 2022, Hanesbrands’ revenue declined 8 percent and operating income was down approximately 35 percent. These factors have led Moody’s adjusted debt/EBITDA to increase to 5.4x for the year-ended Dec 31, 2022 from 3.3x a year earlier while Moody’s EBITA/interest has also reduced to 3.3x from 5.0x over the same time period. Amidst this challenging operating environment, the company is also contending with materially higher interest rates as it looks to refinance approximately $1.43 billion that matures in 2Q’2024 which will further weaken interest coverage.
“The current weak operating environment is anticipated to run through 2023 as retailers still contend with consumer demand softness and further inventory de-stocking. Moody’s anticipates leverage and coverage to deteriorate through 1H’23 with leverage potentially peaking as high as approximately 7.0x by 2Q’23. However, earnings are expected to improve in 2H’23 as the company benefits from lower-cost inventory and normalization in demand. This should lead to Moody’s adjusted leverage to be slightly above 5.0x and EBITA/Interest to be just below 2.0x by year-end 2023.”
S&P downgraded the issuer credit rating on Hanesbrands to ‘BB-‘ from ‘BB’. S&P assigned a ‘BB+’ issue-level rating and ‘1’ recovery rating to the proposed $750 million senior secured term loan B due in 2030. S&P lowered its rating on the company’s 3.5 percent euro-denominated unsecured notes to ‘BB-‘ from ‘BB’ with a ‘3’ recovery rating, and lowered its rating on the company’s 4.875 percent and 4.625 percent senior unsecured notes to ‘BB-‘ from ‘BB’, and revised the recovery rating to ‘4’ from ‘3’.
The negative outlook reflects that S&P could lower its ratings in the next 12 months if the company does not maintain leverage below 5x and make progress toward generating positive free operating cash flow (FOCF).
S&P said in its analysis, “The downgrade reflects our expectation for leverage to remain in the 4.5x-5x range by the end of 2023 despite a change in capital allocation strategy.
“Hanesbrands reported financial results for fiscal 2022 lower than our previous expectations. The company began 2022 with strong demand for its products and was unable to fulfill all orders. However, consumers abruptly pulled back on spending in the second half as inflation in consumer staples cut into discretionary income. Additionally, spending on apparel shifted to dressier attire for returning to work, occasions, and travel, categories Hanesbrands does not supply. Lastly, inventory rebalancing at retailers in North America created an excess inventory for many apparel issuers, resulting in a more promotional end of the year and increased warehousing costs. Credit metrics significantly deteriorated to leverage near 5x for 2022 and negative FOCF of about $470 million. Year-over-year EBITDA margins fell about 300 basis points to the low-teens percent, in line with our expectations.
“Given elevated leverage, management has made substantial changes to its capital allocation strategy, including publicly committing to a full suspension of its dividend, despite its credit agreement dividend basket allowing for greater flexibility. Its recently amended credit facility restricts dividends to $75 million per year, a significant reduction from its previous $250 million dividend basket, and typical annual payout of $200 million, which was 45 percent of FOCF in 2021. The suspension of the dividend will enable the company to allocate cash flow to repay debt. In our 2023 forecast, we assume FOCF is used to reduce revolver borrowings by $325 million, leading to some leverage reduction to 4.8x in 2023. Despite the weak cash flow generation in 2022, the company is not pulling back on its $150 million of capital expenditure (CAPEX) and technology investments for its Full Potential Plan. This plan involves significant capital for automation and to increase capacity to reduce lead time and lower operating costs. Hanesbrands will also expand its U.S. west coast fulfillment center to reach customers more efficiently. Speed to market is a competitive differentiator for the direct-to-consumer channel and younger consumers, all necessary to achieve its long-term plan to reach $8 billion in revenue.
“Hanesbrands is also barred from buying back shares under its credit agreement during the covenant relief period. The company has an authorization of $600 million over the next three years and repurchased $25 million worth of shares in 2022. Given the company’s focus on leverage reduction, we do not expect it to buy back shares until its leverage is in line with its target levels. We still expect the company to operate with a preference for dispositions over acquisitions with proceeds used to repay debt.
“The proposed refinancing will significantly increase interest costs, but we still forecast an FOCF recovery in 2023.
“Hanesbrands’ management has indicated it will refinance its 2024 unsecured debt consisting of $900 million, 4.625 percent notes and $535 million (adjusted for foreign exchange), 3.5 percent euro notes in the first quarter of 2023. Concurrent with this rating action, we assigned ratings to the proposed $750 million term loan B, which will take out a portion of the 2024 notes with the expectation that another near-term debt issuance will take out the remainder of the 2024 notes. Given the Secured Overnight Financing Rate of 4.3 percent, we believe the company’s proposed and upcoming issuance will be at rates significantly higher than those for its existing debt, which will eat into cash flow generation. Despite higher interest costs, we forecast about $450 million of FOCF in 2023 mainly due to inventory winding down as the company cut production in the second half and accounts payable reversals because it still had to pay vendors despite stopping production.
“The weaker than expected operating performance will push out Hanesbrands’ long-term plan targets to 2026 from 2024.
“Hanesbrands reported an 8 percent net revenue decline for 2022 compared to 2021, driven by 10.7 percent declines in the innerwear segment and 7.4 percent declines in the activewear and international segments from weakness in demand and inventory fluctuations, but also due to the European innerwear business being sold, foreign exchange and a ransomware attack. Furthermore, this year hurt the company’s ability to hit its 2024 $8 billion revenue target laid out on its end-of-2021 investor day. Management has pushed out its targets to 2026. The increase in sales is largely contingent on the Champion brand reaching $3.2 billion in global revenues, but its declines are derailing progress. Although we expect the casualization and health and fitness trends to continue to support growth for activewear longer term, near-term volume pressure will likely continue as the economy slows and inflation persists. Sales volumes also face difficult year-over-year comparisons as activewear demand last year benefitted from more remote working and stronger consumer discretionary income. We believe the brand still has equity, pricing power, and the ability to enter into new product categories and expand its geographic reach, making its targets still achievable.”
