Gildan: a market leader in apparel

Gildan will be affected by coronavirus, but its stock may be interesting given that it is an above-average business with a low valuation (it would have a P/E of 10.3 in a non-coronavirus environment).  It has some strong competitive advantages over its competitors that should hopefully allow the company to eventually expand beyond North America and to increase its market share in Europe (which is only a tenth of their business despite Europe having a greater population than the US and Canada).  The stock has been a 30-bagger since 1998 although it has seen very little growth in recent years.

I don’t think Gildan is extremely undervalued at the moment.  However, it can be worth watching the stock as the impact from coronavirus may drive the share price even lower.

Understanding apparel

Unfortunately, the apparel industry is really, really bad at explaining its product to its B2B customers (let alone the retail consumer).  Why should you buy a Gildan Hammer t-shirt that costs more than double what Gildan’s cheapest t-shirt costs?  How much softer is it than the cheaper shirt?  I’m really not sure.  While Gildan could create its own subjective scale to rate its products against each other, I could not find this information.

Here are some key things to know about shirts:

  1. Durability:  Almost all shirts nowadays use polyester thread instead of cotton thread because polyester is more durable.  It is possible for a polyester shirt to be far more durable than a cotton shirt, but the apparel manufacturers often will not explain this to you.  They will not tell you which of their shirts are more durable.
  2. Softness:  Polyester can be scratchy and is used in many of the least comfortable shirts.  It can also be softer than the best cotton.  Simply go to Walmart and feel the polyester on the cheap plush toys, or find a retailer that sells soft shirts made out of 100% polyester (*they may be hard to find).  The quality of polyester varies wildly.  However, manufacturers generally do not provide information on polyester quality or softness.  The best way to figure out softness is to feel a shirt.  I would classify shirts into 4 tiers:
    1. Cheap.  These garments use the cheapest cotton, acrylic, polyester blends, etc.
    2. Soft cotton.  How soft cotton is depends on how it is woven, how it is spun, the quality of the cotton, etc.  The cotton in dress shirts and in jeans tend to be woven into a “knit” fabric that is inelastic and not soft compared to the “woven” fabric used in t-shirts.  Flannel and terried fabrics are processed in a way that makes them soft.  It’s various differences that make some cotton shirts softer than others.
    3. Polyester blends.  While polyester ranges in softness, polyester that is designed to be soft is softer than 100% cotton.
    4. Rayon, viscose, and micromodal blends.  Blending in some amount of these semi-synthetic fibres can make a shirt even softer than a polyester blend.  In the screenprinting apparel business, these are generally the triblend shirts (a blend of polyester, cotton, and rayon).
  3. Thickness isn’t a very good marker of quality.  Thickness makes a shirt less see-through (“sheer”) and have less drape (nipples will show through less).  Thickness makes a shirt warmer and slightly more durable.  However, it has downsides.  It makes a shirt feel less soft and it makes the shirt take longer to dry if its wearer is sweating.  Most expensive shirts are actually thinner than the cheapest models.
  4. Cotton shrinks.  While it is possible for a manufacturer to greatly reduce shrink (e.g. to less than half an inch in the chest) and to make the final product more consistent in size, consumers don’t care enough about this.  It’s hard to find shrinkage information from apparel manufacturers.
  5. “True to size” is a lie.  First of all, t-shirt sizes aren’t standardized; we don’t specify sizes in terms of chest circumference.  Secondly, people have different body shapes and fit preferences.  True to size is not something that exists.  While manufacturers could make shirts that have very little shrink and are highly consistent in size, they generally don’t bother because only a small percentage of consumers care.
  6. Quality control.  Even in the pricier high-end models, quality control tends to be fairly shoddy.  A shirt’s label may fall off, the seams may have puckering, there may be untrimmed threads, etc. etc.  Shirts will often have garbage on them because nobody bothered to spend a few seconds to pick a trimmed thread off the shirt.

In the apparel industry, Bella Canvas is the best at explaining their product’s features to its customers (in my opinion).  Despite being the best at marketing, they don’t do a great job because their marketing people aren’t apparel experts and make questionable claims in their Youtube videos.  Nonetheless, they are much better than their competition (e.g. Gildan, Next Level) at marketing their product and explaining why their product is better than cheaper competing products.

Customer misconceptions

Many retail consumers would rate a cheap 100% cotton Gildan shirt as better than a more expensive polyester/cotton blend or triblend shirt.  This may occur for various reasons:

  1. They have the misconception that the thicker shirt is more expensive and better.
  2. They have the outdated misconception about polyester being a cheap fibre and cotton being a premium fibre.
  3. They’ve heard of Gildan and have never heard about Gildan’s competitors.

So, unfortunately, consumers generally do not know how to spot quality.  On Youtube, you can find interesting advice such as assuming that the thicker shirt is more expensive.  This does not work for screenprinting shirts as almost all of the most expensive shirts are thinner than the cheapest shirt from Gildan (if you measure by weight divided by area).  While it is possible to market shirts that are much better than a 100% cotton shirt, 100% cotton shirts currently make up most of the market at all price points (even for $200+ t-shirts).

Among screenprinters and businesses buying blanks, the perception of quality is different.  Because these people are extremely sensitive to their costs, they know which shirts are more expensive.  This seems to be the major factor in how they perceive the quality of a shirt.

Gildan focuses on efficiency and cutting the right corners

Gildan moves its labour to the cheapest countries.  Shortly after buying American Apparel, Gildan moved most of the labour off-shore.  This is presumably because many retail consumers say they care about “ethical” labour conditions but they don’t really care.  For example, there wasn’t much outrage when consumers paid for made-in-US t-shirts from American Apparel and then saw many of the garment workers kicked out of the country by US immigration officials.  I would argue that America did not treat these workers ethically and it’s questionable as to whether or not buying American Apparel contributed to more ethical labour conditions.  In any case, the market for “ethically” made apparel is a very small niche market.  Gildan does cater to the made-in-US crowd by marketing a more expensive model that is made largely by visible minorities living in the US.

Something else that Gildan does well is that the company designs its products with the right tradeoffs.

  1. Tube construction versus side-seam:  With the tube construction, the main part of the shirt is a tube rather than 2 sheets of cut cotton that are sewn together via the side seams.  The advantage of the tube construction is that it requires less stitching labour and causes less fabric waste, saving a few pennies per shirt.  The downside is that only a box shape is possible.  A Bella Canvas shirt, which will have a side-seam, is slightly bigger around the belly than the chest to accomodate people with bellies.
  2. Not dyeing the polyester in cotton/polyester blends:  The dyes that work on cotton don’t work on polyester and vice versa.  Dyeing both parts of the shirt would require an additional dyeing step which costs more money.  If you instead use polyester that is (close to) white and combine that with dyed cotton, the shirt will have a vintage “heathered” look.  Additionally, using undyed white polyester makes it easier to screenprint the shirt.  If the polyester is dyed, the screenprinter has to worry about dye sublimation and may have to apply an undercoat layer to the shirt.  Gildan-owned brands like Anvil generally shy away from dyeing the polyester, saving a production step.
  3. Spending money on the right things.  Gildan’s cheapest shirt is slightly thicker than the cheapest shirts from Fruit of the Loom (owned by Berkshire) and Hanes.  It is also thicker than most shirts at higher price points.  This makes the shirt feel like it is higher quality to the consumers who erroneously belief that thicker is better.  Here are prices from JiffyShirts.com, which sells at a little above wholesale prices:
    • Gildan G500 – $1.69 – 5.3 oz thickness (weight in ounces divided by a square inch)
    • Hanes 5280 – $1.68 – 5.2 oz
    • Fruit of the Loom 3931 – $1.79 – 5.0 oz
    • *Note: actual prices vary as some distributors will do sweetheart deals with their biggest customer.
  4. Cheap dyeing.  The consumer generally doesn’t notice inconsistencies in colour from shirt or shirt, or that the supposedly “black” shirt isn’t as black as another shirt.  Gildan also engages in overdyeing.  If an unpopular colour does not sell, they will re-dye it into another colour (usually black).

Gildan has a distribution advantage

Gildan’s competitor Bella Canvas faces a big obstacle selling in Canada because it is difficult to buy a Bella Canvas shirt at a good price.  For example, the American version of the JiffyShirts.com website sells the Bella Canvas 3001 for US$3.91 or around CAD$5.47.  The Canadian sister site, JiffyShirts.ca, sells the same shirt for $8.40 (+54%).  Canadian distributors like Technosport also sell the 3001 at a much higher markup than buying direct from Bella Canvas wholesale.

It is advantageous for shirts to be in warehouses near customers so that screenprinters can quickly receive product to fulfill an order; screenprinters will not keep an extensive inventory on their premises because there are thousands of combinations of sizes, colours, and shirt models.  Two of the four Ontario distributors listed on Bella Canvas’ site have dropped Bella Canvas from their distribution line-up.  Gildan’s bigger competitors are Hanes and Fruit of the Loom.  These competitors are generally disadvantaged in distribution because their products are in fewer warehouses.

It makes sense for Canadian buyers to switch away from Bella Canvas to Anvil products (Anvil is owned by Gildan), which are only slightly lesser quality (Anvil makes more quality compromises than Bella Canvas) but are far more attractive price-wise due to lower distributor markups.

Gildan has a scale advantage

Machines, skilled labour, and unskilled labour are all used to produce t-shirts.  There are fixed costs that Gildan heavily leverages.  Since research and development are a fixed cost in producing machines, Gildan can use its size to negotiate lower prices.  While you might think that clothing is a low-tech industry, there is actually a huge amount of technology that goes into making a shirt.  Machines that spin cotton into “ringspun” cotton are slowly taking over the industry as it results into stronger yarns.  This strength can be sacrificed to make the shirt softer.  There is a lot of technology that goes into automating production as much as possible.  Robots are doing more and more of the fabric cutting.  Dyeing the fabric and fighting shrinkage involves a lot of chemistry, machinery, and finding new ways of dyeing shirts at lower cost.  Machines help automate the process of making the colours consistent from shirt to shirt (Gildan has lower standards than higher-end manufacturers).  A lot of research and development goes into making the product cheaper and higher quality.  Shirts nowadays are generally higher quality than shirts of previous generations.

As far as unskilled labour, Gildan does have minor scale advantages there.  There are fixed costs in setting up operations in the lowest-cost countries and moving from one cheap country to an even cheaper country.  Gildan shifted Anvil and American Apparel operations to cheaper countries shortly after buying those companies.

Coronavirus

Shirts are often made specifically for large events such as church events/retreats, school events, conventions, band tours, etc. etc.  Because so many of these events have been cancelled due to coronavirus, the hit in demand will flow through to screenprinters and ultimately to Gildan.  These are sales that will not go into a backlog and they will be lost forever.

Eventually the market will normalize and go back to normal.  Coronavirus will eventually blow over.  In the worst case scenario, the virus behaves like the Spanish Flu and infects most of the world (the Spanish Flu infected around 27% of the people in the world).  Eventually, enough people will have been exposed to it that there are no more people to infect.  Many people would die but it won’t be as bad as the Spanish Flu (17-50M killed, perhaps more than 100M).  The world will definitely survive it because it looks like coronavirus is less lethal than the Spanish Flu.  The Dot-Com Bubble was far deadlier to stock prices than the Spanish Flu even though the latter killed so much of humanity.  Stock prices went up during the Spanish Flu, although one could argue that valuations were extremely low back then.

Coronavirus won’t be anywhere near as bad as the Spanish Flu.  There is good news and bad news:

  • A handful of countries have been successful in containing it due to quick and decisive action from their governments and/or healthcare systems: Hong Kong, Singapore and Taiwan.  Hong Kong has been able to contain the virus despite its unpopular puppet government keeping borders to China open.  As of March 17, it is currently quarantining all arrivals from foreign countries other than China, Taiwan, and Macau.  Schooling has been cancelled since late January.
  • The virus peaked in China and South Korea (source: worldometers.info) a few weeks ago.  These are not the countries to be worried about.
  • And now for the bad news: most countries did not act effectively in containing the virus.  Containment practices vary widely from country to country.
    • Some populations are encouraged to wear masks or have a cultural inclination towards wearing masks.  The Canadian government discourages healthy individuals from wearing masks (even though silent carriers won’t know that they are infected).
    • Hong Kong did not close its border to China while some others countries like Taiwan were decisive in placing travel restrictions.
    • Some cultures practice frequent hand-washing while others do not.
    • Some countries make it easy to get tested for coronavirus without the risk of infecting others in a doctor’s clinics or medical staff at a hospital; other countries do not have their testing infrastructure in place.
  • While I don’t know what the best practices are, it seems that Hong Kong has been successful in its effort without draconian measures and actions that are more damaging to the economy (e.g. travel bans over mandatory quarantine).

Unfortunately, the virus is spreading in the United States, Italy, Spain, Germany, France, and other countries.  At some point, I would expect these countries to step up their efforts against the virus.  I would expect large events and gatherings to drop even further as it is increasingly becoming socially acceptable to cancel large gatherings to help protect lives (and to ditch the “I won’t bow to fear mongering” mentality).  The fear factor may linger and hurt attendance of large events after the virus dies down, so the aftereffects of the virus on the apparel industry may linger.  Eventually, I would expect that people will go back to their normal lives.

My guess is that there will be a very, very tough environment for at least a few quarters but probably not more than 2 years.  Effective containment, a vaccine (these take a while), or widespread infection will ultimately cause the pandemic to die down.

The negative impact from large events being cancelled will be smoothed out slightly by distributors taking higher inventory levels.  Distributors are typically out of stock for particular colours and it will make sense for them to raise their inventory levels.  This may delay the full impact to Gildan by a quarter.

Gildan is likely currently hiding earnings to a very small degree

The company is constantly changing its estimated useful life assumptions and I can’t think of a good reason as to why it should do that (unless it wants to massage its earnings).  Here’s what their accounting assumptions looked like from 2017 to 2018:

Changing the accounting assumptions in this manner likely results in Gildan reporting D&A expenses earlier.  This will lower upcoming reported profits and push their recognition further out into the future.  “Cookie jar” accounting refers to the practice of hiding profits now so that they can be reported later in case management would like to beat analyst estimates.

To guess whether or not Gildan is engaging in “cookie jar” accounting, we can also look at the year-over-year change in PP&E.  The 4.4% drop ($990.475M in 2018 versus $1,035.818M in 2017) suggests that Gildan could be hiding profits (in very small amounts).  Of course, Gildan may simply have decreased its capacity slightly and there are no accounting games going on.  I find the latter case to be unlikely given how often Gildan changes its estimated useful life assumptions.  Usually they change from year to year.

From FY2018 to FY2019, the story is a little more complicated.  The estimated useful life for “Manufacturing equipment” changed from 2-10 to 2-20 years.  So that might lead you to believe that Gildan is trying to juice its earnings.  But let’s look at the balance sheets.  Land went from $71M to $120M because Gildan bought land in Bangladesh ($45M) to build a manufacturing hub there.  In the Q1 2019 conference call, management talked about its capacity expansions:

Shortly after the close of the quarter, on April 9th, we finalized the acquisition of a sizable land parcel in Bangladesh for a purchase price of $45 million. The land will be used for the development of our next major manufacturing hub, which will significantly enhance our current production capacity in Bangladesh. Our current plans include the development of a multiplant complex, which will house 2 large textile facilities and sewing operations, and which when fully operational are expected to provide capacity to support well over $500 million in sales. Our previously communicated textile expansion plans in Central America remain unchanged. And as I previously mentioned, the ramp up of production in our newest facility in Honduras, Rio Nance IV, is coming along very nicely. Therefore, together with our existing and planned capacity expansion in our other manufacturing hubs, this new major initiative in southeast Asia, when fully ramped up, will provide manufacturing capability across our global system to support over $4 billion of total sales. The first textile plant in the new Bangladesh complex is expected to be constructed over a 24-month period and will be a large scale state-of-the-art Rio Nance-like facility. Well will start spending CapEx on this facility immediately in 2019, and we expect this plant to start ramping up during the latter part of 2021. When complete and fully ramped up, we expect this first facility to support approximately $300 million in additional sales.

Despite expanding capacity, PP&E only went up modestly from $990M to $995M or +0.4%.  GIldan’s profitability is clearly understated.  If the accounting reflected the company’s increased capacity, then the PP&E balance would have gone up more and reported earnings would have been higher.

Low growth in recent years

Unfortunately, Gildan’s growth has been relatively modest in recent years and is projected to be relatively modest.

  • FY2016: $2,585M in revenue
  • FY2017: $2,751M in revenue
  • FY2018: $2,909M in revenue
  • FY2019: $2,824M in revenue (3% annual growth since 2006)
  • Analyst projected 2020: $2,897M in revenue (I would expect Gildan’s revenue to be much lower than this)
  • Analyst projected 2021: $2,995M in revenue

In the long run, I think that management will find ways to increase its market share outside of North America.  They have done so in the past and they will probably do so again as they have cost advantages over their competitors.  Historically, Gildan has a track record of buying its bankrupt competitors (e.g. Anvil, American Apparel, etc.).  It would make sense for Gildan to slowly gain share in Europe as it gets its costs lower through its Bangladesh expansion.

To be fair, Gildan does make mistakes.  It is likely that Gildan has had missteps with its Printwear and Branded Apparel segments, which is likely why the company did not break them out for FY2018 (see 2(c) on page 55).

Closing thoughts

COVID-19 will be a huge pothole in the road for Gildan as demand will almost certainly plummet in the short term.  Bella Canvas has announced price reductions as screenprinters are seeing their school and events business disappear completely.  The coronavirus situation will impact daily life even more in North America because we have not been doing enough to contain the virus’ spread.  We will probably enter a period where only supermarkets and pharmacies are open because many developed countries have been ineffective in containing the virus.  But the world is not ending.  Sooner or later, the virus will blow over (hopefully without killing too many people) and life will go back to normal.  When that happens, low interest rates will likely push money back into stocks and cause valuations to quickly rise.

It’s possible that buying Gildan now is too early.  While the virus in China and South Korea is dying off (Chinese factories have restarted at partial capacity), the situation will get worse in many developed countries and daily life will be disrupted.  It’s possible that Gildan stock gets hit even harder once its earnings start to reflect the impact of widespread event cancellations.  Regardless, it looks slightly cheap now and may become more compelling if investors’ fears and worries drive the stock down even more.

*Disclosure: I am long shares of Gildan (ticker symbol GIL on the NYSE and TSX).

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