Innerwear and activewear manufacturer Hanesbrands (HBI -1.91%) beat its own guidance when it reported its fourth-quarter results, but the company is preparing for a very tough 2023. Debt reduction is now the top priority, and a victim of this shift is the dividend. Hanesbrands has decided to eliminate the dividend entirely, a move that prompted investors to dump the stock on Thursday.
For the long-term health of the company, getting rid of the dividend for now is the right course of action. With sales plunging and margins contracting, Hanesbrands needs all the cash it can get its hands on to bring its debt levels and interest payments down.
A rough fourth quarter
Hanesbrands suffered a year-over-year sales decline of 16% in the fourth quarter. A slowdown in consumer spending in the U.S. is part of the problem, but retailers are also reducing their inventories. That means replenishment orders are down, which has more than offset Hanesbrands' recent price increases.
Sales were weak across all of Hanesbrands' segments. Innerwear sales slumped 19%, activewear sales tumbled 16%, and international sales dropped 12%. Operating margin contracted in each segment due to lower sales, higher input costs, and the costs associated with a manufacturing time-out. A large charge related to deferred tax assets led the company to report a large net loss, but adjusted earnings per share was still positive at $0.07.
Hanesbrands' guidance wasn't any better. High manufacturing costs that are embedded into the company's current inventory will hurt margins in the first half, and the company expects consumer demand will continue to be weak throughout 2023. Hanesbrands sees full-year sales between $6.05 billion and $6.20 billion, an adjusted operating profit of at least $500 million, and adjusted earnings per share between $0.32 and $0.42. All of those numbers are down from 2022.
The plan to right the ship
Hanesbrands has been working to reduce its inventory levels, and it's succeeded in terms of units. At the end of 2022, the company was sitting on 6% fewer inventory units. However, the total value of that inventory was still up 25% year over year thanks to higher costs. As Hanesbrands sells its higher-cost inventory in the first half of 2023, it should be able to release working capital and drive cash flow. The company is expecting to produce around $500 million in operating cash flow for the full year.
Getting rid of this high-cost inventory will also help boost margins in the latter half of the year. Hanesbrands expects both its gross and operating margins to be "meaningfully higher" as the company exits 2023.
Getting to that point, though, will require Hanesbrands to be especially frugal. The company chose to eliminate its dividend entirely, which will free up cash to reduce its debt. Hanesbrands ended the year with $3.6 billion of long-term debt, and interest payments totaled $157 million. That debt will become a bigger problem as interest rates rise. Hanesbrands is now planning to refinance its debt maturing in 2024 during the first quarter, which will likely result in higher interest payments.
Hanesbrands paid out $209 million in dividends in 2022, a sizable chunk of cash that can now be directed at debt reduction. Hanesbrands is planning to use all its free cash flow to knock down its debt.
Dividend cuts are never fun, but if the company can make it through this downturn, better days will likely be ahead. Hanesbrands is targeting annual revenue of $8 billion and an operating margin of 14.4% by 2026. The company is still turning an adjusted profit despite slumping demand, and it appears as though the worst of the cost inflation that forced up manufacturing costs is over.
For patient investors willing to part with the dividend, Hanesbrands stock is a turnaround story worth considering.
