S&P Global Ratings revised its debt ratings outlook on Hanesbrands, Inc. to negative. The rating agency said Hanesbrands reported second quarter 2022 earnings below S&P’s expectations, specifically leverage of about 4.2x, compared to prior expectations of mid-3x, and due to the underperformance at its key growth brand Champion.
Hanesbrands also disclosed that a cyberattack in Spring 2022 hurt operations by $100 million in revenue and $35 million in operating profit, on a management-adjusted basis, by disrupting its supply chain for three weeks.
S&P revised its forecast downward to account for slower global growth of the company’s key brand, Champion, weaker demand for its products and higher costs. S&P projects leverage to remain elevated at 4.6x for the fiscal year 2022 as the company manages through a challenging macroeconomic environment while pursuing its strategic initiatives.
The negative outlook reflects that S&P can lower ratings over the next 12 months if the company does not reduce leverage below 4x. S&P affirmed its ‘BB’ issuer credit rating on Hanesbrands and ‘BB’ issue-level rating on its senior unsecured debt.
S&P wrote in its analysis, “The negative outlook reflects operating performance below our previous expectations and our view that credit metrics may remain deteriorated over the next 12 months. We project leverage will be about 4.6x for the fiscal year ended 2022, which is above our prior expectation of 3x-3.5x and above our 4x downgrade threshold. Given the current macro environment and the company’s recent performance, we believe there is risk that leverage can remain elevated above 4x through the first half of fiscal 2023. Additionally, we now expect free operating cash flow to be negative for fiscal 2022, below our prior expectation of $375 million. This is largely due to the company’s increased inventory levels due to prior pandemic-induced supply chain challenges and more recently due to a shift in demand for its products. Despite the change in cash flow generation, the company is not pulling back on its $150 million in capital expenditures (CAPEX) for its Full Potential Plan. The company’s plan involves significant capital for automation and to 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 direct-to-consumer (DTC) channel and younger consumers, all necessary for Hanesbrands to achieve its long-term plan and why CAPEX is not being changed at this time.
“The weaker than expected operating performance is primarily because of lower demand; less so from a cyberattack Hanesbrands reported a 13.6 percent net revenue decline for the second quarter of 2022 compared to 2021 driven by double-digit declines in all of its reporting segments. Reported operating income and EBITDA for the same periods fell by $80 million. While 5 percent of the revenue decline and $35 million of the operating income decline can be attributed to a cyberattack in the spring, the remaining weakness in results reflects declining demand for its products, including its strongest activewear brand, Champion. The cyberattack shut down parts of its global supply chain and left the company unable to fulfill orders for three weeks. This combined with an already challenged supply chain as well as inflation limits consumers’ ability and willingness to spend on discretionary products leading to the company’s earnings miss. Furthermore, we believe this year will hurt the company’s ability to hit its 2024 $8 billion revenue target laid out on its end of 2021 investor day. The increase in sales is largely driven by Champion reaching $3.2 billion in global revenues by 2024, but the brand’s segment declined 18 percent in the second quarter, derailing its progress. We believe the brand still has brand equity, pricing power, and the ability to enter into new product categories and expand its geographic reach, making its targets still achievable.
“We expect share buybacks to be minimal over the next 12 months and mergers & acquisitions (M&A) to take a pause given negative cash flow generation. The company’s recent performance does not change our expectation for a balanced capital allocation over the next 12 months with a preference for dispositions over acquisitions. Hanesbrands announced the authorization of a $600 million three-year share buyback program in early 2022 and repurchased $25 million worth of shares in 2022. Given we do not forecast the company to generate free operating cash flow in 2022, we do not expect further cash usage to buy back shares. This is consistent with our opinion that the company will buy back fewer shares in years in which there is macroeconomic uncertainty or any operating headwinds, which is currently the case for fiscal 2022. Therefore, we expect the company to maintain a balanced capital-allocation policy. In fact, management reiterated its financial goal to manage net leverage in the 2x-3x range. Investment activity should remain muted given these goals. Although the company spent $100 million in the second quarter of 2022 to acquire the Champion trademark from Wolverine World Wide, with plans to release innovations in the category, M&A is not likely in the near term. The company is currently leveraged at 3.5x on a covenant-defined basis, and will use any cash flow generated to repay the debt to ensure compliance and restore leverage to its publicly stated targets. We would view raising debt to pursue M&A over the next 12-to-18 months as a shift in financial policy.
“The trend toward casual clothing will continue to support Champion’s growth over the long-term, but near-term demand will be pressured by a slowing economy. The activewear segment led by Champion and Hanes has been the company’s growth engine. The innerwear segment, which accounts for about one-third of total sales, has declined in 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. Although we expect the casualization and health and fitness trends to continue to support growth for activewear longer term, the segment will likely continue to face near-term volume pressure as the economy slows and inflation persists. Sales volumes also face difficult year-over-year comparisons as active wear demand last year had benefitted from more remote working and stronger consumer discretionary income. Hanesbrands plans to continue investing 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 $3.2 billion brand by 2024. However, given recent performance and an uncertain operating outlook, these goals may not be achievable.
“Recent performance likely delays 2024 financial targets, leading us to view management and governance less favorably. Hanesbrands has a relatively new management team, having announced the appointment of new CFO Michael Dastugue in May 2021 and later announced its long-term financial targets. Given the recent performance, we believe the company will be delayed from hitting its 2024 performance targets and view management’s planning process, consistency of strategy with organizational capabilities, and ability to control the execution of strategy less favorably.
“The negative outlook reflects that we could lower the ratings over the next 12 months.”
Photo courtesy Hanesbrands/Champion
