2022 was a brutal year for the stock market. The S&P 500 (^GSPC 1.02%) dropped 19.4%, the Dow Jones Industrial Average (^DJI 0.40%) suffered an 8.8% decline, and the tech-heavy Nasdaq Composite (^IXIC 2.02%) tumbled 33.1%. High-flying growth stocks that soared during the first two years of the pandemic were hit particularly hard as investors realized that trees don't grow to the sky, and that the era of ultra-low interest rates wasn't going to last forever.
Stocks that were priced more reasonably going into 2022 didn't necessarily fare any better. Many cheap stocks got much cheaper, in some cases dropping below their March 2020 lows. One example is apparel manufacturer Hanesbrands (HBI 0.22%). The stock lost more than 60% of its value last year as elevated inflation and recession fears spooked investors. At its low, Hanesbrands stock dipped below where it traded when the pandemic was shutting down economies in early 2020.
That multi-year low didn't last long. Since Christmas, Hanesbrands stock has rebounded about 25%. And while the company's results are going to be rough this year, pessimism is running far too high.
Feeling some pain
Hanesbrands faces two distinct issues. First, the business of selling underwear is not recession proof at all. In fact, the so-called "men's underwear index" is sometimes touted as a way to predict whether a recession is coming. When sales of men's underwear start to decline, that can indicate that consumers are having a tough time financially.
Second, after struggling to secure enough inventory at the start of the pandemic, some retailers are now drowning in too much inventory. Walmart is Hanesbrands' largest customer, accounting for 17% of total sales in 2021. The mega-retailer saw its inventory rise well above historical levels last year, and working down that inventory will inevitably involve fewer orders of some products.
WMT Inventories (Quarterly) data by YCharts
Hanesbrands is already feeling some pain. Sales were down 7% year over year in the third quarter, or down 3% at constant currency. Guidance for the fourth quarter was much worse. The company is expecting a 15% revenue decline at constant currency because of a worsening macroeconomic environment. Hanesbrands' own inventory has surged as well, with the value of inventory up 31% year over year. The company expects its cash flow from operations to be a loss of $400 in 2022 as it grapples with slumping sales.
Weathering the storm
Hanesbrands has taken a few steps to help it better weather this economic storm. First, the company has amended its credit agreements to allow it to temporarily have a net-debt to adjusted-EBITDA ratio higher than normal. That ratio will revert to the previous level in the first quarter of 2024, giving Hanesbrands a full year of increased financial flexibility.
Second, the company is working on bringing down its inventory levels. Hanesbrands is slashing its SKU count even as it brings new products to market. Already, the count is down 40% from its peak. With commodity costs and ocean freight representing significant cost headwinds, simplifying its supply chain as much as possible should help lessen the impact.
Hanesbrands' balance sheet is a legitimate reason for concern. $253 million in cash was paired with around $3.7 billion of debt at the end of the third quarter. The company expects its cash flow to return to more normal levels in 2023, achieved partly by reducing inventory levels, but an unpredictable economy could throw in a wrench in that plan.
While there is considerable risk associated with Hanesbrands stock, the beaten-down valuation more than accounts for the downsides. At its low in late December, the stock bottomed out at $5.65. Based on its guidance for adjusted earnings per share in 2022, the price-to-earnings ratio was less than 6. Earnings could decline in 2023, although the average analyst estimate calls for adjusted EPS to remain roughly unchanged from 2022 levels. At the current stock price, the PE ratio is closer to 8.
If Hanesbrands can get through this downturn, the stock could easily double or triple as earnings recover and pessimism recedes. Of course, that will be easier said than done. For Hanesbrands investors, 2023 will certainly be a rough ride.
