When you spend a lot of time analyzing different segments of the market, it isn’t all that unusual to come across two competing companies in an industry that both look appear to have a pretty good argument as a good bargain opportunity in the making. When it happens, as an investor you have a decision: which one should you pick? Or, if you have the capital to work with, should you bother choosing at all, or simply work with both of them? It’s the kind of thing that I like to call “a good problem to have,” because you get to choose between two pretty good things, and that usually means that whatever you decide to do, you’ll have a pretty good chance of seeing it work out okay.
The problem, of course, is that just because you might find a couple of stocks in the same industry that look good, it doesn’t mean that everything is as it seems. Sometimes what looks like a great opportunity is, in reality a bigger risk than you might realize until it’s too late. This is the situation I found myself in earlier this week when I started evaluating Gildan Activewear Inc. (GIL) and HanesBrands Inc. (HBI), two stocks in the Textiles & Apparel industry. You’ve probably heard of HBI, of course; I don’t think there are too many men who haven’t worn a Hanes or Champion t-shirt, or that many women who haven’t bought Maidenform or Wonderbra undergarments or L’eggs nylon stockings. You may not be as familiar with GIL; they make the same products as HBI, and they sell them under some of their own brands, like Gold Toe, American Apparel, and others. A big portion of their business, however, focuses on branded apparel for the printwear market.
I’ve followed both stocks for some time, in part because I like both of their products; for another, I think that while the industry exists in the Consumer Discretionary sector, which can be subject to economic cyclicality, the specific niche they both reside in makes them pretty attractive as stocks that should hold up well when the economy shifts to the downside. I like the idea of working with stocks like these as defensive positions; and the fact is that both stocks have generally underperformed the market over the course of the year.
This week the S&P 500 pushed above resistance from its late January high after the Trump administration it had reached an agreement with Mexico to rework the NAFTA trade agreement; the market seems anxious to treat the news as the first domino to fall in favor of easing trade tensions with America’s largest and most important trading partners. There’s a long way to go, however, and a completion of the agreement, or of seeing it affect the other countries the Trump administration has targeted with tariffs in the way many hope it could isn’t a given. Even if things work out as many hope in the long run, the fact remains that the market is so extended that a significant reversal is inevitable sooner or later. That means that it’s smart to keep paying attention to defensive-oriented stocks that can position you to weather the storm of a reversal more effectively than stocks trading at extremely high valuations are.
The fact that both stocks are well below their 52-week highs is a positive, of course, but it still doesn’t mean that they both automatically represent a terrific value right now. The truth is that if you simply paid attention to each stock’s current long-term downward trend, you’d probably conclude HBI is the better option, since it is only about $1 above its 52-week low price right now, down nearly 25% so far in 2018 and almost 32% lower for the past twelve months. By comparison, GIL is down only about 14% so far for the year, and only about 6% for the last twelve months. Digging deeper into the fundamentals for each stock, however paints a pretty different picture.
Gildan Activewear, Inc. (GIL)
Current Price; 29.45
- Earnings and Sales Growth: Over the last twelve months, earnings grew by a little over 6%, while revenue increased almost 7%. The numbers for GIL have gotten better recently, however, with earnings growing nearly 53%, and revenue improving more than 18% in the last quarter. The company cited strength in its United States-focused brands in its last earnings report, which is interesting given the fact this is a Canadian stock that most would likely figure to be hurt by ongoing trade tensions with its neighbor to the south.
- Free Cash Flow: GIL’s free cash flow is healthy, at more than $388.24 million. This is a positive, although this number has declined since the beginning of the year from a peak a little above $500 million.
- Dividend: GIL’s annual divided is $.44 per share, which translates to a yield of 1.49% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for GIL is $9.15 and translates to a Price/Book ratio of 3.27 at the stock’s current price. The stock’s historical average Price/Book ratio is 3.32, suggesting at first blush that the stock is fairly valued. The picture gets more interesting, however, when you factor in the stock’s Price/Cash Flow ratio, which is currently running more than 70% below its historical average. That puts the stock’s long-term target price above $51 – well above its all-time high price from January of this year at around $34.50 per share.
Hanesbrands Inc. (HBI)
Current Price: $17.54
- Earnings and Sales Growth: Over the last twelve months, earnings declined by more than 15%, while revenue increased about 4%. The numbers for HBI are better in the last quarter, with earnings growing 73%, and revenue improving about 16.5% in the last quarter.
- Free Cash Flow: HBI’s free cash flow is healthy, at more than $462 million. This is a positive, although this number has declined since the first quarter of 2017 from a peak at close to $900 million.
- Dividend: HBI’s annual divided is $.60 per share, which translates to a yield of 3.43% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for HBI is only $2.13 and translates to a Price/Book ratio of 8.22 at the stock’s current price. The stock’s historical average Price/Book ratio is 7.18, suggesting at first blush that the stock is slightly overvalued. Like GIL, the picture gets more interesting when you consider the stock’s Price/Cash Flow ratio, which is currently running more than 200% below its historical average. That puts the stock’s long-term target price above $38, which is above the stock’s highest point since early 2015.
Based on the numbers shown so far, both stocks look like pretty great value plays, right? Not so fast, because the truth is that I think HBI carries a much higher risk than GIL does right now, despite its much lower current price and attractive upside forecast. A significant divergence between these two companies comes when you dive into their use of debt and their operating margin profile.
GIL currently shows $900 in long-term debt on their books. In and of itself, of course, debt isn’t automatically a bad thing, and GIL’s debt to equity ratio of .47 generally suggests the debt they have is very manageable. More importantly, the percentage of Net Income to Revenue has improved from 12.5% for the last twelve months, which is pretty healthy, to more than 14% in the last quarter. By comparison, HBI has more than $4.1 billion in long-term debt to go along with a debt to equity ratio of 5.41. That is a very high number that indicates HBI is one of the most highly leveraged companies in its industry. Their operating profile also suggests that they could have problems servicing their debt; over the last twelve months, Net Income as a percentage of Revenues was barely .5%. This number did improve in the last quarter to a little over 8%, but remains significantly below the level maintained by GIL.
When most of the information about two stocks looks similarly attractive, a discriminating investor has to be able to split hairs to determine if one company’s opportunity is more worth the risk than the other. In this case, the fact that GIL shows a much more manageable debt burden, with operating discipline that has enabled it to not only maintain a stable level of profitability, but also to improve it, makes it a better bet than its more recognizable competitor.