Invest in 1 Company That's Investing in Itself

From innerwear to outerwear Hanesbrands has got you covered from head to toe.

Jul 14, 2014 at 11:49AM

Quick, if you own a business how do you make money? Sell more, spend less, and generate cash. It's simple, anyone could do it. In fact, Hanesbrands (NYSE:HBI) outright states this in its annual report. When a multi-million dollar company is able to state its business strategy with language even a toddler can comprehend, you know you have a winner.

The shopping spree
Within the last four years, Hanes has made three big acquisitions. In November 2010, Hanesbrands, purchased GearCo Inc, a leading seller of licensed logo apparel in collegiate bookstore. In October 2013 it bought Maidenform, a global intimate apparel company. More recently, Hanesbrands announced the purchase of DBApparel for a hefty sum of over $500 million.

But Hanesbrands is not the only company in its industry trying to grow through acquisition. Its competitor, Gildan (NYSE:GIL), is also on an acquisition spree. Within the same time span, Gildan has made 5 acquisitions according to its 40-F reports, including Gold Toe Moretz, CanAm Yarns, and Anvil Holdings. The companies' vary in specialty: from yarn spinning to screen printing and apparel decoration.

In the latest annual report, 11% of sales comes from Hanesbrands' international exposure. With the acquisition of DBApparel, Hanesbrands has the opportunity to increase its international exposure, particularly in the European market. According to the 8-K, once synergies are realized, Hanesbrands will gain $125 million in operating profit, $1.00 per share of earnings, and $125 million to cash flow from operations. The company stated that it will take about 3 to 4 years to realize the synergies.

Valuation metrics
Below is a chart of various margins from 2007 to 2013 for both Hanesbrands and Gildan.

The top line margins and operating margins have remained a bit more stable for Hanesbrands compared to Gildan, although net profit margins have been very volatile for both companies. Carefully note that both companies were profitable during the 2008 financial crisis. Both companies' profitability during this period is a positive attribute, indicating that the businesses are able to survive during tough times.

Although Gildan may appear more attractive based on its profit margins, Hanesbrands' earnings per share have trended higher, signaling another positive indication of the company's growth potential.

Cash flow
While earnings allude to a company's profitability, free cash flow presents an alternative perspective. I calculated Free Cash Flow for Hanesbrands as Cash Flow from Operations + Cash Flow from Investments.

In 2010 and 2013 free cash flow was negative. This makes sense, as the company geared up for its acquisition and is consistent with growing the business. Along similar lines, 2008 consisted of large capital expenditures to help in the growth of Hanesbrands. I expect the free cash flow this year to be negative given that the company has continued to spend a lot on acquisitions.

(You may be wondering if Hanesbrands is a profitable company, why is it's free cash flow sometimes negative. The reason is that the financial statements are prepared using the accrual accounting method versus the cash basis method. For example, revenues are recorded when services are provided not when cash is received.)

One item that could be alarming are that the cash totals compared to long term debt on the balance sheet are pretty low.

Consider the following scenario, if the company runs into tough times, its cash will be depleted and it will have to start liquidating its assets to pay off the debt.

However, given the company is trying to grow, the low cash balance and high debt level appears quite normal.

Verdict
Given that Hanesbrands is trying to expand even though it already has a very broad appeal, this is the company that should be held for the very long term. To paraphrase Peter Lynch, find a business anyone can run. Hanesbrands is that business.

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Ravi Bala has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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