This Trade Might Just Knock Your Socks Off

Let’s see how elastic the shares of Hanesbrands Inc. (HBI)  are….

The company is best known for underwear — the stock came up in a conversation on Doug Kass’ Daily Diary on Real Money Pro Thursday after a contributor noted it was getting shellacked in trading after earnings. I acted on the opportunity immediately via covered call orders. This is one of the reasons I am on the Daily Diary almost every day for new potential ideas.

The stock had somewhat of a rebound off deeply oversold levels on Thursday, but it still sets up well for a covered-call trade. On Thursday, Hanesbrands posted fourth-quarter earnings results. Top- and bottom-line numbers were roughly in line with expectations. But management reduced its sales guidance for next quarter by approximately two percent from the midpoint of the new range given. Leadership also forecasts a loss in the first quarter from the profit of 13 cents a share the analyst consensus was expecting (more on that below). It should be noted that fourth-quarter revenue exceeded the top end of the sales guidance, leadership provided with its third-quarter earnings report.

The bigger trigger for the nearly 25% plunge in the stock that day was the company said it was suspending its dividend payout. With a dividend yield in the high single digits, this move obviously greatly disappointed the income investors holding the shares and they promptly jettison the equity from their portfolio.

There are several important things to keep in mind here. First, Hanesbrands is still going to be profitable company even as leadership now sees a small loss coming in the first quarter of 2023. Some unproductive facilities are closing, while Hanes lays off some staff, consolidates sourcing vendors, and aggressively cuts costs.

Second, the company makes products that face significant inelastic demand. Consumers may put off purchasing a new TV in tough economic times, but underwear is obviously more essential. More importantly, the company is using all of its free cash flow from suspending its dividend payout (60 cents a share annually) on reducing debt. It will do so until it brings the company’s leverage back to a range that is no greater than two to three times on a net debt-to-adjusted earnings before interest, taxes, depreciation, and amortization basis.

In an environment with rising rates, this is critical for any enterprise with a significant debt load that will roll over. Hanesbrands has approximately $3.6 billion in long term debt to go along with a $2.2 billion market cap. The company is expecting some $500 million in operational cash flow in fiscal 2023. The story is likely to get bolstered in the back half of 2023 thanks to improvements from current initiatives and cost adjustments, not to mention it will be easier to beat comps.

Fiscal 2023 will be an inflection year for Hanesbrands, but it is important to remember the company made nearly a buck a share of profits in fiscal 2021 before soaring inflation and continued global supply chain issues dented the outlook for most manufacturers. By the close of 2023, I fully expect the company to have lower leverage. Investors at that point should be looking forward to a rosier 2024, and at some point, the reinstatement of a dividend payout again. Meanwhile, I want to get paid while the company goes through a couple of challenging quarters. Therefore, below is the covered call strategy that makes sense around this name.

Option Strategy:

To establish an initial position in HBI using a covered call strategy, do the following: Selecting the July $7 call strikes, fashion a covered call order with a net debit in the $5.85 to $5.95 a share range (net stock price – option premium). This strategy provides downside protection of approximately 12% and 18% of upside potential even if this stock does little over the option duration.

I think this stock has a high probability of being range bound through the first half of 2023, in which case I will probably roll the trade close to option expiration date, picking up another nice option premium.