Undervalued Dividend Growth Stock of the Week: Hanesbrands Inc. (HBI)

Just take a look around you.

You know what you’ll notice? 

You’ll notice quality products and/or services that practically make the world go round.

You don’t even have to go far to see this play out.

Your bathroom. Your closet. Your pantry. Your cell phone. Your electricity. Your driveway. The things you see on the way to work.

So on and so forth.

An exercise I performed when I first started investing a number of years ago was to look at all of the products and/or services I was personally using.

What I discovered was that there was a small group of truly exceptional companies providing these products and/or services to not just me but also millions or billions of people just like me.

And I thought to myself, “Why not invest in these businesses and profit from the very products and/or services I’m personally paying for?”

Indeed, that’s exactly what I started doing.

And it eventually snowballed into the real-life and real-money six-figure dividend growth stock portfolio I now own and control.

This portfolio, by the way, generates the five-figure passive dividend income that I need to cover my real-life bills, rendering me financially independent in my early 30s.

Look, I’m no genius.

And this is why I’m such a proponent of dividend growth investing.

Dividend growth investing doesn’t require one to be a genius in order to successfully invest, build wealth, and generate the passive investment income necessary to sustain and enjoy oneself in retirement.

One can simply invest in some of the best businesses in the world and collect a growing stream of passive dividend income along the way.

See, many of the best companies become the best by providing the world the quality products and/or services it demands. This results in a lot of growing profit. And that growing profit translates into growing dividend income. That growing dividend income can then be used to pay for real-life bills, eventually rendering one financially independent.

Nothing genius about this.

To see what I mean, just check out some of the blue-chip stocks you can find on David Fish’s Dividend Champions, Contenders, and Challengers list.

Mr. Fish has compiled information on more than 800 US-listed stocks that have paid rising dividends for at least the last five consecutive years.

You’ll see a lot of companies on that list that are providing you your toothpaste, gasoline, laundry detergent, mobile phone data, electronics, lunchtime meal, tissue paper, etc.

Like I said, it’s the quality products and/or services that make the world go round.

And you, too, can profit from this. 

But it’s not as easy as just buying a random dividend growth stock off of Mr. Fish’s list.

There’s a bit more to it than that.

Specifically, one should first make sure a company is within their circle of competence. If you can’t easily understand how a company makes and will continue to make money, while paying you your increasing dividend, you may want to stay away.

If a company is within your circle of competence, it then obviously behooves one to perform a full quantitative and qualitative analysis on a business.

This means looking at the fundamentals (revenue, profit, balance sheet), analyzing risk, and determining competitive advantages.

After all, there are naturally different levels of quality among the 800+ US-listed dividend growth stocks out there.

Finally, one should aim to estimate (with reasonable accuracy) the intrinsic value of a business, with the intention of buying a high-quality dividend growth stock (that’s already passed muster) at an attractive valuation.

This is because undervaluation can confer multiple benefits to the long-term dividend growth investor.

Price is simply what something costs, but value is what something is actually worth.

Knowing the latter gives context and meaning to the former.

An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and less risk.

That’s all relative to what the same stock would otherwise present if it were fairly valued or overvalued.

The higher yield comes about because price and yield are inversely correlated; all else equal, a lower price will result in a higher yield.

That higher yield positively impacts total return right off the bat, due to the fact that total return is comprised of two components: income (dividends or distributions) and capital gain. The income part of the equation is given a boost via the higher yield.

In addition, the capital gain component is given a possible boost via the “upside” that exists between a lower price and a higher value.

While the stock market isn’t necessarily very good at appropriately pricing stocks in the short term, price and value tend to more closely track each other over the long run.

And so any temporary “misprising” can lead to a lot of upside, if taken advantage of.

That’s on top of whatever natural upside is available as a business becomes naturally worth more as it increases its profit.

This all serves to reduce risk, as paying less money is clearly less risky than paying more for the same business.

When you pay less, you introduce a margin of safety, which gives one a buffer just in case a business doesn’t perform as expected.

With these benefits in mind, one should see why an undervalued high-quality dividend growth stock can be such a fantastic long-term investment.

However, it might be surprising to learn that it’s not necessarily all that difficult to go about estimating intrinsic value for most dividend growth stocks out there, as fellow contributor Dave Van Knapp has shown via his “lesson” on valuation.

That “lesson” is part of an overarching series of articles that discuss the entire strategy of dividend growth investing, showing how just about anyone can use this strategy to grow their wealth, passive income, and freedom.

What I’m now going to do is highlight a high-quality dividend growth stock that appears to be undervalued right now…

Hanesbrands Inc. (HBI) is an apparel marketer and manufacturer, with a portfolio of apparel brands across t-shirts, innerwear, casualwear, activewear, socks, and hosiery.

I mentioned looking around you to find great investment ideas, by seeing the products and/or services that you (and everyone else) are using.

Well, it doesn’t get much more obvious, necessary, or ubiquitous than clothing.

This is a fantastic example of successful long-term investing not requiring one to be a genius. Anyone can understand and invest in clothing. It’s that easy.

Hanesbrands has a number of well-known apparel brands under their umbrella, with a particular focus on activewear and undergarments.

Some of their brands include: Hanes, Champion, Playtex, Bali, Maidenform, JMS/Just My Size, Wonderbra, and Gear for Sports.

The business segments are as following: Innerwear, 43% of fiscal year 2016 sales; Activewear, 26%; International, 26%; and Direct to Consumer, 5%.

The company was founded in 1901, but the company was spun off from Sara Lee Corporation in 2006.

As such, the dividend history in regard to the current interation of the company is somewhat limited, but the dividend growth track record looks to be building into something special.

The company has increased its dividend for five consecutive years.

Not terribly lengthy, but the growth has been tremendous: the three-year dividend growth rate stands at 26%.

Notably, the company is due for a dividend increase any day now, which I expect to be in the double digits.

For reference, the last dividend increase was a monstrous 36%. I wouldn’t be surprised at all to see the upcoming increase to be somewhere between 15% and 20%.

With a payout ratio of 37.3%, there’s still plenty of room for sizable dividend increases for the foreseeable future.

However, the payout ratio has obviously been steadily climbing since the company instituted and started increasing its dividend. And so dividend growth will have to slow a bit moving forward.

Still, the company appears poised for very strong double-digit dividend growth for the near future, which is especially appealing when you consider that you’re pairing that with a current yield of 2.73%.

Assuming a static valuation, one’s total return expectations should be the sum of yield and dividend growth. If you can pair a near-3% yield with double-digit dividend growth, that’s setting you up for a very attractive total return.

That yield is appealing however you want to slice it.

It’s well above the industry average. It’s quite a bit higher than the broader market. And it’s more than 100 basis points higher than the stock’s own five-year average.

Plus, this is the yield as it sits now, before the upcoming dividend increase – a sizable dividend increase which will likely be announced within days.

So there’s a lot to like about the dividend. And this is all coming from a business that’s very simple to understand.

We’ll now dig into the business and its fundamentals, as we have to first build business growth expectations before we can build dividend growth expectations (which are important to any dividend growth investor). These expectations will then help us estimate the intrinsic value of the stock.

But before we build a forward-looking expectation, we must first look at what the company has done over the long haul.

Although we don’t invest in where a company has been (but rather where it’s going), knowing what a company has done over the long term (using the last decade as a proxy for the long term) gives us a pretty good idea about what kind of trajectory a business is on.

So we’ll look at the last decade of top-line and bottom-line growth. And then we’ll compare that to a professional estimate of near-term EPS growth.

Combining and blending the past and future like this should give us a pretty good idea as to what Hanesbrands is capable of.

The company’s revenue expanded from $4.475 billion in fiscal year 2007 to $6.028 billion in FY 2016. That’s a compound annual growth rate of 3.37%.

It’s not phenomenal sales growth, but the nice thing about the growth is that it was fairly clockwork. Other than a dip in 2008-2009 (as expected, seeing as how that period included one of the greatest recessions my generation will ever see), the top-line growth was secular.

However, the bottom line fared quite a bit better, thanks to various accretive acquisitions and substantial margin expansion.

Earnings per share came in at $0.33 (after accounting for a 2015 4-1 stock split) for FY 2007. EPS grew to $1.40 in FY 2016. That’s a CAGR of 17.42%.

Very impressive bottom-line growth here.

The company has been on an acquisition spree in recent years, but the results show these moves to be prescient and prudent. Some recent acquisitions include: Pacific Brands Ltd., Champion Europe, Knight Apparel, Inc., DBA Lux Holding S.A,  Maidenform Brands Inc.

These acquisitions have bolstered the company’s breadth and depth, while also giving it more international exposure. And every single acquisition was complementary in one way or another, serving to the core competencies of the business.

Looking out over the next three years, CFRA is predicting that Hanesbrands will compound its EPS at an annual rate of 16%.

That would be roughly in line with what the company did over the last decade, indicating no material slowdown in growth.

In my view, this would be incredible. Frankly, though, Hanesbrands doesn’t have to grow at that kind of rate to make it a fantastic investment moving forward. Even something closer to 10% annual growth over the next 3-5 years would be enough to provide for very strong dividend growth and total return potential, all on a low-risk and easy-to-understand business.

For perspective on this, the most recent quarterly report (Q3 2017) showed 22% YOY diluted EPS growth.

Again, impressive.

The company now has more debt than it did a decade ago, along with a flat outstanding share count. This is due in part to the number of acquisitions they’ve made.

While the balance sheet could stand to be markedly improved, I don’t believe it’s extremely worrisome.

The long-term debt/equity ratio stands at 2.87, while the interest coverage ratio is almost 5.

The latter number concerns me a bit more than the former does, but the acquisitions have obviously been quite accretive to the company’s bottom line, indicating that the balance sheet can be improved via future growth.

Said another way, the company should be able to grow its way out of a balance sheet that isn’t fantastic.

Profitability – especially in terms of recent improvement – is phenomenal.

Over the last five years, the company has averaged annual net margin of 6.96%, while return on equity averaged 31.7% per year over that time frame.

Net margin essentially tripled over the last decade. And the company’s margin is now competitive with much larger competitors that have great scale and success. Just a massive improvement here.

This business is right in my wheelhouse.

It’s a very simple, low-risk business model. The products are ubiquitous and necessary. The fundamentals (other than the balance sheet, which should improve) are rather outstanding. Management appears to be running the business at a high level.

Meanwhile, the stock offers a healthy yield with double-digit dividend growth that’s supported by a very modest payout ratio.

There’s just not much to dislike here.

Of course, the balance sheet should – and likely will – be improved, but the growth makes up for some of the additional debt.

The International and DTC segments could – and likely will – be a larger part of the business, but this also provides the potential for a long growth runway.

And competition is always an issue.

But the valuation, in my view, offers way more upside than downside here, making for a very compelling long-term investment idea…

The stock is trading hands for a P/E ratio of 13.63, which is obscene for a company growing at 15%+. That’s a PEG ratio below 1.

That P/E ratio is obviously well below the broader market’s P/E ratio. And it’s substantially lower than the stock’s own five-year average P/E ratio of 23.1.

The P/CF ratio is about 1/3 its three-year average.

And the yield, as noted earlier, is more than 100 basis points higher than its recent historical average, which is before considering the upcoming dividend increase.

This picture adds up to undervaluation, but what might we be looking at? What might the stock be worth?

I valued shares using a dividend discount model analysis.

I factored in a 10% discount rate and a long-term dividend growth rate of 7.5%.

This DGR is very conservative when only looking at near-term dividend growth, but that’ll flatten out at some point.

The company’s long-haul potential should actually be greater than this, but I like to err on the side of caution when doing very long-term projections like this.

The DDM analysis gives me a fair value of $25.80.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

My view is that this is a highly undervalued dividend growth stock, but my valuation is limited to my own analysis. We’ll thus compare my valuation to what select professional analysts have come up with, which adds perspective and depth.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates HBI as a 5-star stock, with a fair value estimate of $32.00.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates HBI as a 4-star “BUY”, with a fair value calculation of $32.07.

I came out low here, which is due to what is arguably a pretty conservative take on the company’s long-term DGR. Averaging these three numbers out gives us a final valuation of $29.06, which would indicate the stock is potentially 32% undervalued.

Bottom line: Hanesbrands Inc. (HBI) offers investors a high-quality, low-risk, easy-to-understand business model selling ubiquitous products to people all over the world. A yield near 3%, double-digit dividend growth, an upcoming dividend increase, and the potential that shares are 32% undervalued are just a few reasons why this is one of my top 10 stocks for 2018.

— Jason Fieber

Note from DTA: How safe is Hanesbrands Inc. (HBI) dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 48. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, HBI’s dividend appears average with a moderate risk of being cut. Learn more about Dividend Safety Scores here.

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