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After just about meeting expectations in the second quarter, Hanesbrands (NYSE: HBI ) recently beat the Street's estimates. Despite marginal growth in its top line and a weak back-to-school season, the clothing maker managed to report double-digit bottom-line growth thanks to the company's strategy. Let's unravel.
Under the layers
A gulf was created between the company's top and bottom lines by rising operating profit. Hanes' third-quarter revenue increased 5%, to $1.23 billion, whereas its net income shot up by 48%, to $90.8 million. A handsome increase in operating profit -- innerwear business up 44%, outerwear business up 45%, and direct-to-consumer business up 16% -- contributed to the difference in growth.
Hanes has been consciously working toward improving its operating profits. As Chairman and CEO Richard A. Noll put it, "Our approach, pricing to at least maintain operating margin is working, while units do in fact decline, they declined much less than price increases, and are driving good results for us."
Although higher prices may have helped bring down the number of items sold, they ultimately helped net income grow. Male underwear and socks, part of the innerwear business segment, had some of the largest price hikes, but still performed well.
Last years' takeover of Gear For Sports contributed significantly to Hanes' outerwear sales. The segment realized a 45% increase in operating profits. Without Gear For Sports, the segment still realized a 10% increase in profits.
Is pricing the key?
Raising prices to fight high input costs and register profits might be the way forward. Other clothing and apparel companies, like Under Armour (NYSE: UA ) and Abercrombie & Fitch (NYSE: ANF ) , are enacting similar price hikes. In an industry with difficult margins, raising prices is sometimes the best, or only, way to manage rising input costs. I'd also keep an eye on Aeropostale (NYSE: ARO ) , which is sensitive to the same input costs as these companies.
Unfortunately, the strategy doesn't always pan out. Last quarter, G-III Apparel (Nasdaq: GIII ) offered discounts to fight weak demand and sell more. While revenues grew, profit still fell, leaving it short of Street forecasts. So when it comes to apparel companies, raising prices isn't a sure-fire fix.
Time to pull up its socks?
It's commendable that Hanes has been able to post decent profits in spite of a meager revenue growth by controlling costs (operating margin has gone up to 12.4% from 9.7%). It cannot ignore its top line, which also needs a boost. Hanes plans to use cheaper cotton in the next quarter so that it can price its products more attractively. Hanes expects sales to go up to $1.2 billion to $1.3 billion in the next quarter and hopes to yield earnings per share of $2.75 to $2.85 for the full year, up from last year's EPS of $2.16. These estimates don't indicate an expected jump in sales anytime soon, though.
Foolish bottom line
Hanes seems to have got the balance right -- boosting profit by controlling costs. The top line is an area of concern, and the company is already taking steps to stitch the seams. Hanes' strong income statement along with its future pricing and cost-cutting strategies make me bullish about the company. I think this stock is worth watching.
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