EW - HanesbrandsV4.pub
November 2009
EARLY WARNING H ANESBRANDS I NC . ( NYSE :
HBI )
Very Aggressive 7th Percentile Equity Risk Ranking 2 Key AGR Concerns • High leverage, with Debt to Equity of 9.6x (98th percentile) • High Goodwill, Low and declining Cash Ratio • Low SG&A Expenses • Declining Depreciation Expenses, increasing Deferred Tax Assets • High Incentive Compensation for CEO & CFO • Chairman is CEO • Restructurings since 2006 • Share repurchases of $75 million since 2007, despite high debt and low cash. 7.2 million shares remaining in a 10 million authorization Additional Risks • Customer concentration, with 43% of total sales accounted for by Wal-Mart (27%; Very Aggressive AGR rating) and Target (16%; Aggressive AGR rating). 65% of sales accounted for by top ten customers. • Exposure to fluctuations in raw material costs (primarily cotton), despite periodic short-term supply agreements and hedges • Pension 86% funded at 1/3/2009; contributed to steep increase in Accumulated other comprehensive loss ($260 million at third quarter 2009) • Anti-takeover provisions, including stockholder rights plan, authorized preferred shares, staggered Board of Directors • Low director and executive officer ownership (2.4% total) • Below investment grade credit ratings: Ba3 / BB- (Moody’s / S&P)
Industry: Apparel/Accessories Market Cap: 2.47B Previous Close 25.87 (11/10/2009): 52wk Range: 5.14 - 26.61 Litigation Ranking: 1 1-yr Litigation probability: 1.6% Bankruptcy probability 2.01% Bankruptcy percentile 13th Last Audit: PriceWaterhouseCoopers LLP Period End: 7/4/2009 SEC Filing: 8/6/2009 Rating Published 8/28/2009 Short interest ratio* 6 Ability to Borrow: Easy Avg. daily volume: 1,087,591
*Short interest ratio = number of shares shorted / average daily volume Sources: Audit Integrity; Reuters
Background Hanesbrands Inc. is a consumer goods company with a portfolio of leading apparel brands, including Hanes, Champion, C9 by Champion, Playtex, Bali, L’eggs, Just My Size, barely there, Wonderbra, Stedman, Outer Banks, Zorba, Rinbros and Duofold. The company designs, manufactures, sources and sells a broad range of apparel essentials such as t-shirts, bras, panties, men’s underwear, kids’ underwear, casualwear, activewear, socks and hosiery. Operations are managed and reported in five operating segments: Innerwear, Outerwear, International, Hosiery and Other. Hanesbrands was spun off from Sara Lee on September 5, 2006.
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EARLY WARNING Flagged Metrics Table The following table identifies the metrics that directly impact Hanesbrands’ AGR Rating of Very Aggressive.
Accounting Risks
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Leverage (Debt over Equity) Hanesbrands’ leverage has been flagged for the past twelve quarters in the 95th percentile and above for its industry. Total debt at third quarter 2009 was $2 billion, stemming from the spin off from Sara Lee. The debt includes a Senior Secured Credit Facility, Second Lien Credit Facility, Floating Rate Senior Notes, and Accounts Receivable Securitization Facility. In March 2009, the company amended the Senior Secured Credit Facility and Accounts Receivable Securitization Facility to obtain additional cushion for leverage ratio and interest coverage ratio covenant requirements. Companies that have high levels of long term debt in relation to equity can experience problems in debt repayment and reduced flexibility in funding future projects. Generally, the higher this ratio, the more risky a creditor will perceive its exposure in the business, making it correspondingly harder to obtain credit.
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EARLY WARNING
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Goodwill over Total Assets Hanesbrands’ goodwill has been flagged for the past three quarters in the 83rd percentile and above for its industry. Its goodwill of $322 million accounts for 9% of total assets. No impairments have been taken in the past three years, leaving considerable room for future write downs. Goodwill is generally considered to be harder to value, of lower quality than fixed assets, and has the risk of overvaluation, since it is not amortized over time like other assets. The potential for write-downs in future periods is high, with firms often forced to book impairment expenses on this goodwill.
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SG&A Expenses over Operating Expenses Hanesbrands’ SG&A expenses have been flagged for eight of the past nine quarters in the 18th percentile and below for its industry. Comparably low SG&A expenses are a red flag for expense recognition issues. Management may manipulate these expenses in many ways: through the intentional underaccruing of expenses; by offsetting the expenses against operating expenses in one of the liability "reserve" accounts; by capitalizing SG&A expenses on the balance sheet instead of recording them as operating expenses; or by netting a gain from a sale of affiliate against SG&A expense, artificially lowering recurring expenses.
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EARLY WARNING
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Cash Ratio Hanesbrands’ cash ratio has been flagged for two of the three past quarters in the 11th percentile and below for its industry. Its cash of $38.6 million as of third quarter 2009 is down 55% and 78% from the 1-year ago and 2years ago periods, respectively. Relatively low cash ratios can indicate a company’s low liquidity and potential difficulty in meeting its current obligations with only cash on hand, if sales revenues should disappear.
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Depreciation Expense over PP&E: Hanesbrands’ depreciation expenses have been flagged for the past four quarters in the 11th percentile and below for 1-year change. Relatively low depreciation expense is a red flag for expense recognition issues. Extended depreciation (and amortization) policies substantially reduce overall expenses and boost earnings, and raise concerns about the adequacy of expense recognition and the possibility that fixed assets are being overstated.
•
Deferred Tax Assets over Operating Expenses: Hanesbrands’ deferred tax assets are in the 96th percentile for its industry, and have been flagged for the past nine quarters in the 80th percentile and above for 1-year change. Excessive deferred income tax assets are a red flag for expense recognition issues and are a concern because timing the release of deferred tax reserves can be used to smooth income and manage earnings. Also, the adequacy of valuation allowances set up against these assets and the appropriateness of the timing of their draw-downs entails judgment of considerable difficulty.
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EARLY WARNING Corporate Governance and High Risk Events
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Board Chairman is also CEO Richard A. Noll has served as the Chief Executive Officer of Hanesbrands since April 2006, and as Chairman of the Board of Directors since January 2009. Although many exceptional companies are managed at the top by a joint Chairman-CEO, the lack of separation in these positions is cause for concern as a corporate governance choice. Chairman-CEOs represent one of the most extreme cases of lack of independence between a company's Board and its executive officers. All things equal, it is far superior to have as few insiders on the Board of Directors as possible, particular in the top positions.
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Average Ratio of Incentive Comp to Annual Comp of the CEO & CFO Hanesbrands’ average ratio of incentive compensation to annual compensation was flagged for four of the past five quarters in the 90th percentile and above. Large-scale incentive income may indicate that company executives have incentives toward short-term profits and stock gains over longer-term health of the company. Performance-based compensation can motivate executives to manipulate company books in order to boost earnings and thus increase the value of executive options. Additionally, excess compensation also indicates significant dilution of company stock, income, or both, and should be reviewed carefully.
•
Restructurings Hanesbrands has been implementing a large-scale restructuring program since its spin off. As of third quarter 2009, the company has recognized approximately $262 million and announced approximately $253 million in restructuring and related charges since the spin off, of which approximately half has been noncash. Restructuring efforts have included closures of manufacturing facilities and distribution centers, and elimination of management and administrative positions. Restructurings are high risk events since they are commonly associated with aggressive expense recognition issues, with restructuring reserves potentially being used for income smoothing. Reserves for restructurings can be exaggerated, and used to offset operating expenses in the future, or current operating expenses can be improperly classified as relating to the restructuring.
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EARLY WARNING Conclusion Analysis of metrics related to accounting and corporate governance is essential in building a complete picture of forensic risk. The prevalence of high risk events and opaque financial reporting indicates an elevated risk of equity loss and other negative events, such as shareholder litigation and financial restatement. Management’s incentive for personal enrichment and utilization of aggressive accounting to achieve this end is a dangerous combination, and both are at the stakeholder’s expense. For Hanesbrands, there are both accounting and corporate governance issues which contribute to the company’s high risk profile. As a result, Hanesbrands is within the AGR rating category of Very Aggressive, and in the bottom 7th percentile of all rated companies.
Audit Integrity Client Services Phone: (877) 880-8820 E-mail: [email protected] Website www.AuditIntegrity.com
Audit Integrity, Inc. and its affiliates, Directors and Officers of the company may own stock or options to purchase or sell stock in the companies mentioned on our website and in our publications and may elect to increase or decrease the size of these positions at any time. Audit Integrity, Inc. however, is not directly or indirectly compensated for the specific views, opinions or recommendations expressed in its research reports. This document is for information purposes only and is not to be considered a solicitation to buy or sell any security. Neither Audit Integrity nor any other party guarantees its accuracy nor makes any warranties regarding its usage. Modification or reproduction of this report is forbidden without explicit permission. Copyright © 2009 Audit Integrity, Inc.
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EARLY WARNING H ANESBRANDS I NC . ( NYSE :
HBI )
Very Aggressive 7th Percentile Equity Risk Ranking 2 Key AGR Concerns • High leverage, with Debt to Equity of 9.6x (98th percentile) • High Goodwill, Low and declining Cash Ratio • Low SG&A Expenses • Declining Depreciation Expenses, increasing Deferred Tax Assets • High Incentive Compensation for CEO & CFO • Chairman is CEO • Restructurings since 2006 • Share repurchases of $75 million since 2007, despite high debt and low cash. 7.2 million shares remaining in a 10 million authorization Additional Risks • Customer concentration, with 43% of total sales accounted for by Wal-Mart (27%; Very Aggressive AGR rating) and Target (16%; Aggressive AGR rating). 65% of sales accounted for by top ten customers. • Exposure to fluctuations in raw material costs (primarily cotton), despite periodic short-term supply agreements and hedges • Pension 86% funded at 1/3/2009; contributed to steep increase in Accumulated other comprehensive loss ($260 million at third quarter 2009) • Anti-takeover provisions, including stockholder rights plan, authorized preferred shares, staggered Board of Directors • Low director and executive officer ownership (2.4% total) • Below investment grade credit ratings: Ba3 / BB- (Moody’s / S&P)
Industry: Apparel/Accessories Market Cap: 2.47B Previous Close 25.87 (11/10/2009): 52wk Range: 5.14 - 26.61 Litigation Ranking: 1 1-yr Litigation probability: 1.6% Bankruptcy probability 2.01% Bankruptcy percentile 13th Last Audit: PriceWaterhouseCoopers LLP Period End: 7/4/2009 SEC Filing: 8/6/2009 Rating Published 8/28/2009 Short interest ratio* 6 Ability to Borrow: Easy Avg. daily volume: 1,087,591
*Short interest ratio = number of shares shorted / average daily volume Sources: Audit Integrity; Reuters
Background Hanesbrands Inc. is a consumer goods company with a portfolio of leading apparel brands, including Hanes, Champion, C9 by Champion, Playtex, Bali, L’eggs, Just My Size, barely there, Wonderbra, Stedman, Outer Banks, Zorba, Rinbros and Duofold. The company designs, manufactures, sources and sells a broad range of apparel essentials such as t-shirts, bras, panties, men’s underwear, kids’ underwear, casualwear, activewear, socks and hosiery. Operations are managed and reported in five operating segments: Innerwear, Outerwear, International, Hosiery and Other. Hanesbrands was spun off from Sara Lee on September 5, 2006.
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EARLY WARNING Flagged Metrics Table The following table identifies the metrics that directly impact Hanesbrands’ AGR Rating of Very Aggressive.
Accounting Risks
•
Leverage (Debt over Equity) Hanesbrands’ leverage has been flagged for the past twelve quarters in the 95th percentile and above for its industry. Total debt at third quarter 2009 was $2 billion, stemming from the spin off from Sara Lee. The debt includes a Senior Secured Credit Facility, Second Lien Credit Facility, Floating Rate Senior Notes, and Accounts Receivable Securitization Facility. In March 2009, the company amended the Senior Secured Credit Facility and Accounts Receivable Securitization Facility to obtain additional cushion for leverage ratio and interest coverage ratio covenant requirements. Companies that have high levels of long term debt in relation to equity can experience problems in debt repayment and reduced flexibility in funding future projects. Generally, the higher this ratio, the more risky a creditor will perceive its exposure in the business, making it correspondingly harder to obtain credit.
2
EARLY WARNING
•
Goodwill over Total Assets Hanesbrands’ goodwill has been flagged for the past three quarters in the 83rd percentile and above for its industry. Its goodwill of $322 million accounts for 9% of total assets. No impairments have been taken in the past three years, leaving considerable room for future write downs. Goodwill is generally considered to be harder to value, of lower quality than fixed assets, and has the risk of overvaluation, since it is not amortized over time like other assets. The potential for write-downs in future periods is high, with firms often forced to book impairment expenses on this goodwill.
•
SG&A Expenses over Operating Expenses Hanesbrands’ SG&A expenses have been flagged for eight of the past nine quarters in the 18th percentile and below for its industry. Comparably low SG&A expenses are a red flag for expense recognition issues. Management may manipulate these expenses in many ways: through the intentional underaccruing of expenses; by offsetting the expenses against operating expenses in one of the liability "reserve" accounts; by capitalizing SG&A expenses on the balance sheet instead of recording them as operating expenses; or by netting a gain from a sale of affiliate against SG&A expense, artificially lowering recurring expenses.
3
EARLY WARNING
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Cash Ratio Hanesbrands’ cash ratio has been flagged for two of the three past quarters in the 11th percentile and below for its industry. Its cash of $38.6 million as of third quarter 2009 is down 55% and 78% from the 1-year ago and 2years ago periods, respectively. Relatively low cash ratios can indicate a company’s low liquidity and potential difficulty in meeting its current obligations with only cash on hand, if sales revenues should disappear.
•
Depreciation Expense over PP&E: Hanesbrands’ depreciation expenses have been flagged for the past four quarters in the 11th percentile and below for 1-year change. Relatively low depreciation expense is a red flag for expense recognition issues. Extended depreciation (and amortization) policies substantially reduce overall expenses and boost earnings, and raise concerns about the adequacy of expense recognition and the possibility that fixed assets are being overstated.
•
Deferred Tax Assets over Operating Expenses: Hanesbrands’ deferred tax assets are in the 96th percentile for its industry, and have been flagged for the past nine quarters in the 80th percentile and above for 1-year change. Excessive deferred income tax assets are a red flag for expense recognition issues and are a concern because timing the release of deferred tax reserves can be used to smooth income and manage earnings. Also, the adequacy of valuation allowances set up against these assets and the appropriateness of the timing of their draw-downs entails judgment of considerable difficulty.
4
EARLY WARNING Corporate Governance and High Risk Events
•
Board Chairman is also CEO Richard A. Noll has served as the Chief Executive Officer of Hanesbrands since April 2006, and as Chairman of the Board of Directors since January 2009. Although many exceptional companies are managed at the top by a joint Chairman-CEO, the lack of separation in these positions is cause for concern as a corporate governance choice. Chairman-CEOs represent one of the most extreme cases of lack of independence between a company's Board and its executive officers. All things equal, it is far superior to have as few insiders on the Board of Directors as possible, particular in the top positions.
•
Average Ratio of Incentive Comp to Annual Comp of the CEO & CFO Hanesbrands’ average ratio of incentive compensation to annual compensation was flagged for four of the past five quarters in the 90th percentile and above. Large-scale incentive income may indicate that company executives have incentives toward short-term profits and stock gains over longer-term health of the company. Performance-based compensation can motivate executives to manipulate company books in order to boost earnings and thus increase the value of executive options. Additionally, excess compensation also indicates significant dilution of company stock, income, or both, and should be reviewed carefully.
•
Restructurings Hanesbrands has been implementing a large-scale restructuring program since its spin off. As of third quarter 2009, the company has recognized approximately $262 million and announced approximately $253 million in restructuring and related charges since the spin off, of which approximately half has been noncash. Restructuring efforts have included closures of manufacturing facilities and distribution centers, and elimination of management and administrative positions. Restructurings are high risk events since they are commonly associated with aggressive expense recognition issues, with restructuring reserves potentially being used for income smoothing. Reserves for restructurings can be exaggerated, and used to offset operating expenses in the future, or current operating expenses can be improperly classified as relating to the restructuring.
5
EARLY WARNING Conclusion Analysis of metrics related to accounting and corporate governance is essential in building a complete picture of forensic risk. The prevalence of high risk events and opaque financial reporting indicates an elevated risk of equity loss and other negative events, such as shareholder litigation and financial restatement. Management’s incentive for personal enrichment and utilization of aggressive accounting to achieve this end is a dangerous combination, and both are at the stakeholder’s expense. For Hanesbrands, there are both accounting and corporate governance issues which contribute to the company’s high risk profile. As a result, Hanesbrands is within the AGR rating category of Very Aggressive, and in the bottom 7th percentile of all rated companies.
Audit Integrity Client Services Phone: (877) 880-8820 E-mail: [email protected] Website www.AuditIntegrity.com
Audit Integrity, Inc. and its affiliates, Directors and Officers of the company may own stock or options to purchase or sell stock in the companies mentioned on our website and in our publications and may elect to increase or decrease the size of these positions at any time. Audit Integrity, Inc. however, is not directly or indirectly compensated for the specific views, opinions or recommendations expressed in its research reports. This document is for information purposes only and is not to be considered a solicitation to buy or sell any security. Neither Audit Integrity nor any other party guarantees its accuracy nor makes any warranties regarding its usage. Modification or reproduction of this report is forbidden without explicit permission. Copyright © 2009 Audit Integrity, Inc.
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