Gildan Activewear Inc.’s share price has rallied 20 per cent this year and the stock’s valuation is closing in on its highest level of the past five years. This backdrop is all but certain to add some drama to the company’s first-quarter financial results on Wednesday.
The Montreal-based apparel manufacturer has been dazzling investors for years, as it diversifies from making basic cotton T-shirts, underwear and socks to more fashionable and performance-oriented activewear.
Gildan is also winning favour with its strategy of increasing its sales beyond Canada and United States, which together currently account for an overwhelming 90 per cent of sales. The company’s US$88-million deal in 2017 for the American Apparel brand (along with some assets of the bankrupt retailer) fits with this strategy. Gildan’s share price has soared 60 per cent since it struck the deal.
But for all the investor enthusiasm, the numbers suggest that this isn’t a particularly fast-charging company right now. In 2018, sales increased 5.7 per cent. That’s a solid performance, but hardly enough to justify the double-digit gains in the share price.
Worse, profit in 2018 declined 3.2 per cent, year-over-year. After accounting for costs associated with closing and consolidating some operations, adjusted profit increased all of 1.6 per cent.
Given that profits aren’t keeping up with the rising share price, the stock’s valuation is being stretched. At the start of the year, the shares traded at 16.5 times trailing earnings, which is near the low-end of the stock’s valuation over the past five years. Just four months later, the shares trade at 20.2 times trailing earnings, which is near the high end.
That’s okay if Gildan is primed to report stellar first-quarter profits. But by most accounts, this week’s quarterly report will be a sober reminder that the business of selling basic cotton T-shirts to wholesale distributors, screen printers, retailers and consumers isn’t easy.
Mark Petrie, an analyst at CIBC World Markets, lowered his expectations on Friday. He expects Gildan will report an adjusted profit of just 15 US cents a share (the company reports its financial results in U.S. dollars), down from his previous estimate of 25 US cents. That marks a sharp decline from Gildan’s profit of 34 US cents a share in the first quarter of 2018.
Part of the problem is short-term: One of Gildan’s U.S. distributors for blank apparel, Heritage Sportswear, is being liquidated – blowing a US$19-million to US$23-million hole in Gildan’s quarterly results.
Gildan expects that its sales to Heritage, which were about US$60-million in 2018, will be absorbed by other wholesale distributors. But Gildan is also dealing with other challenges. These range from higher input costs to foreign-exchange volatility to a build-up of inventories last year that is making year-over-year comparisons difficult.
Mr. Petrie expects that the shares will trade at US$34 within 12 months (the shares trade in New York as well as Toronto), which is below the current price of the stock. Similarly, Keith Howlett, an analyst at Desjardins Securities, has a price target for its TSX-listed shares of $48. On Monday, the shares closed in New York at US$36.99 and Toronto at $49.75.
Clearly, investors have other thoughts on the stock. They see a company that has done a lot of restructuring over the past couple of years – moving from Gildan-branded socks and underwear to private-label apparel for retailers; it has modified its U.S. distribution channels; and it is in the process of adjusting its manufacturing platform in Mexico, Central America and the Caribbean.
These changes could pay off for the company over the longer term. But the impressive rally this year has lifted the stock to a lofty valuation, putting a lot of pressure on first-quarter results and leaving little room for disappointment. Investors will find out this week whether the stock’s valuation is justified.