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Gildan Activewear Inc

Page 1 May 25, 2017 www.JWCResearch.com

Basic Apparel

Catalyst

In a market that appears to be overpriced, GIL is trading at a discount to both the market and the apparel industry. GIL’s current trailing twelve month (ttm) P/E of ~17x is meaningfully discounted to the S&P 500 at ~21.5x and the consumer durables & apparel industry at ~28x. As investors seek value, we believe that GIL will land on more investors’ radar and will subsequently make a solid run towards our $36 price target.

*Please see disclaimer at the end of this report. 2017 JWC Research. All rights reserved. No part of this report may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying or by any information storage and retrieval system, without permission in writing from JWC Research.

Gildan Activewear Inc - GIL

Buy – Target: $36.00

Current Price: $28.37

Investment Thesis

We believe the market is currently overpriced as the S&P 500 has a P/E of 21.5x. GIL is trading at a P/E of ~17x versus a 5-year historical high of ~34x. Over the past year, Gildan (GIL) is down 4.77%. In the past few years GIL has made significant investments in their manufacturing capabilities giving them an improved cost advantage over their competitors. We believe that the gradual cost advantage they have developed will continue to improve their ability to expand internationally, which is currently less than 10% of sales. GIL’s two segments are printwear and branded apparel. GIL has maintained a dominate printwear position in the United States with almost 70% of the market for a few years. They are now expanding their business to push their printwear capabilities abroad and to continue to grow their higher margin branded apparel business. We believe that GIL has both the plan and ability to execute double digit EPS growth for the next few years.

Source: Bloomberg, JWC Research

Source: Stockcharts.com

Weekly Chart – Gildan (GIL)



Basic Apparel


Source: Company Presentation

Company Description

Gildan(GIL) is a Canadian headquartered manufacturer of basic family apparel. There are 19 company-owned brands currently covered under Gildan’s diversified portfolio (Figure 1), including the most recent acquisition of the American Apparel brand. Their products are mainly sold in printwear and branded apparel retail market. GIL’s manufacturing facilities are based in Central America, the Caribbean Basin, North America, and Bangladesh.

Industry Overview

Competition: The basic apparel (socks, underwear, t-shirts, sweats) manufacturing sector is highly competitive and subject to intense pricing pressure. Such pressures are derived from not only the outstanding number of retailers in the industry, but also the fluctuations of raw materials prices. Historically, revenues have been driven by consumer spending and preferences. Manufacturing efficiencies, cost cutting abilities, and successful sales and marketing campaigns can altogether determine the competitive position of a basic apparel retailer.

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Figure 1. Gildan Brands



Basic Apparel


Figure 2. Cotton Prices

Changing Consumer Tastes: We see some major shifts of consumer tastes in the apparel industry, especially in fashion sports apparel. As more people are inspired by the healthy lifestyle (e.g. yoga etc.), specialized apparel, particularly those with added technology infused features start to attract more consumers’ attention and gain a larger market share. International Expansion: Companies have begun to seek net sales and revenues growth through an international presence. Due to an unfavorable retail environment in the United States, such attempt at international expansion can be both an opportunity and a challenge. Taking foreign exchange risk and consumer behavior into considerations, successful capital investments, marketing strategies and business models in the new market have the potential to drive company growth for the long run.

Cotton: Cotton Prices (Figure 2) have risen from ~$63 in 2015 to ~$73 in 2017 (price per 100 bales which is 50k lbs). Cotton is a primary commodity for most basic apparel companies. Thanks to higher current cotton prices, 2017 and 2018 are forecasted to spur farmers to expand cotton plantings by ~5% worldwide according to the International Cotton Advisory Committee. We expect this to place downward pressure on the price of cotton over the next 12 months. Wrap Up: Success in the highly competitive basic apparel industry is largely dependent of cost controls and operational efficiency. A company’s ability to insulate itself from the volatility of commodity prices will lead to a competitive advantage over the long run.

Source: Bloomberg



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Branded Apparel: Gildan is dedicated to leveraging their core competencies by developing their 19 apparel brands, of which the majority are company-owned. The branded apparel segment, which has its own management team, is headquartered in Charleston, South Carolina. Their products, marketed under company owned and licensed brands, are sold in a variety of retailers including Walmart and the Dollar Store. We believe this segment has significant upside when considering their superior manufacturing process. Printwear (Figure 4): Gildan has more than a 70% printwear market share in the U.S. and continue to pursue additional printwear market penetration and opportunities. GIL has stated their intention to participate further in the fast-growing fashion basics and sports performance categories which we believe could add significant growth to this segment.

Figure 3. Vertically Integrated Production

A Quick Look at Operations

Gildan’s competitive advantage is their ability to consistently improve the efficiency of the manufacturing process. GIL is one of the few basic apparel manufacturers who own virtually every step of the manufacturing process (Figure 3). Vertically Integrated Production: GIL effectively employs vertically-integrated, large-scale manufacturing facilities throughout their production process. One unique advantage GIL has over competitors like Hanes and Fruit of the Loom is their ownership of their yarn spinning facilities. Each of GIL’s five yarn spinning facilities are in the United States and GIL has invested over $400 million in recent years to build state of the art facilities. Although capital expenditures have been higher than industry averages from these upgrades, we expect this will ultimately give GIL a cost advantage in this highly competitive industry.

Source: Company Filings



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Printwear is undecorated activewear (blanks) primarily sold to wholesale distributors who sell them to screenprinters, advertising specialty distributors, and embroiderers, who in turn decorate the products with designs and logos and sell the imprinted activewear into a highly diversified range of end-use markets. These include educational institutions, athletic dealers, event merchandisers, promotional product distributors, charitable organizations, entertainment promoters, travel and tourism venues, and retailers.

Source: Company Filings

Management

Our View: Management has proven their ability to work well in challenging market conditions. They have consistently developed their competitive advantage of a reliable supply chain, short productivity/delivery cycle times, and cost synergies with new acquisitions. We expect them to further develop their brands by investing heavily in sales, marketing and capital expenditures – to continue to improve cost controls. Management’s board is highly independent with only the CEO serving on both the management team and the board. Management’s compensation is mostly derived of share based awards and option based awards. We believe that this structure helps to align management’s incentives with shareholders. The board has a shareholder value approach as they continue to buy back stock. Their most recent buyback program includes ~5% of the shares outstanding.

Acquisitions: One of Gildan’s core strategies is to utilize acquisitions to build their portfolio of brands. They completed three major acquisitions in 2016; Peds, Comfort Colors, and Alstyle. In February 2017, the company acquired American Apparel and certain assets by winning the chapter 11 auction for $88 million. At just $88 million, American Apparel added significant value and notoriety to GIL’s fashion basics product offerings. We believe this new product-mix is helpful in building brand awareness and identity. We expect GIL to continue to focus on manufacturing efficiencies and cost reductions on their new acquired brands. Wrap Up: To promote penetration in the retail markets, GIL continues to increase capacity with their two segments, branded apparel and printwear. The two lines of production are well operated and getting stronger. We expect to see Gildan further develop their presence internationally, which currently represents less than 10% of their EPS.

Figure 5. Printwear Market

Figure 4. What is Printwear?

Source: Company Presentation



Basic Apparel


JWC Valuation

Valuation: GIL has strong free cash flow and an impressive balance sheet. They have leveraged this strength to enhance sales, earnings growth and shareholder returns. Our $36 price target is derived utilizing discounted free cash flow (Figure 7), with a weighted average cost of capital of ~7.8% and a perpetual growth rate of ~3%. Capital Structure: In Q1 2017, GIL had +$42 million free cash flow vs -$52 million and -$107 million in Q1 of 2016 and 2015 respectively. Sales of $665 million were up 12% compared to Q1 2016. GIL was included in the Dow Jones Sustainability World Index (DJSI World Index) for the fourth consecutive year, the benchmark for global leaders in economic, environmental and social responsibility. Overall, we believe that GIL is well positioned to continue to generate strong free cash flow in the coming years.

Source: Bloomberg, JWC Research

Source: JWC Research

Figure 6. Estimates & Key Data

Figure 7. JWC Valuation Calculations



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Risks

Commodity Prices: Since cotton and polyester are the most important raw materials for apparel, Gildan is highly exposed to cotton price movements. The company has purchased contracts and derivatives to hedge risk for commodities. However, if the price for cotton rises significantly in a short period of time and the company faces constant pricing pressure, then their gross margin will be hurt and our valuation will need to be reevaluated. Pricing Power: Pricing power has always been a concern for the basic apparel industry which is a highly commoditized business. Particularly in the printwear segment, there is limited pricing power due to competition, raw material prices and energy cost fluctuations. If Gildan is hit by an unexpected seasonal downturn, inventory levels will change and this will have a material impact on our valuation. Foreign Exchange: With manufacturing facilities located in several countries in Central America and North America, GIL’s revenues are subject to foreign exchange risk. Although they have made efforts to adjust the price of the product to reflect the unfavorable currency market in the past, there will still be a lag between setting new prices and executing them across countries. Therefore, if management fails to respond to currency fluctuations as soon as possible, it would affect the bottom line and ultimately our price target.



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JWC Rating Systems

Buy: The stock’s total return is expected to outperform the S&P 500 over the next 12 months. Avoid: The stock’s outlook and drivers are too unpredictable. This stock should be avoided. Sell: The stock’s total return is expected to materially underperform the S&P 500 over the next 12 months.

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Gildan Activewear Inc Gildan Activewear Inc - GILjwcresearch.com/wp-content/uploads/2017/06/JWC-Research-GIL.pdfGildan Activewear Inc Basic Apparel .com Page 4 May 25, 2017 Branded