Gildan Activewear: Staying Bullish Considering Key Investment Merits

Elevator Pitch

I continue to rate Gildan Activewear Inc. (NYSE:GIL) (TSX:GIL:CA) stock as a Buy. In my prior write-up for GIL published on September 11, 2022, I mentioned about multiple tailwinds for Gildan Activewear such as the nearshoring trend and an increase in yarn supply.

With the current update, I turn my attention to Gildan Activewear's key investment merits, such as a balanced capital allocation approach, the ability to maintain high operating profit margins, and its appealing valuations. My opinion is that GIL's investment merits are sufficient to warrant a Buy rating for the stock.

Gildan Activewear Has A Balanced Capital Allocation Approach

Gildan Activewear takes a balanced approach towards capital allocation, which is one of the factors that differentiates GIL from other potential investment candidates.

On one hand, there are companies which are too aggressive when it comes to capital investment, which eventually leads to value-destructive acquisitions or capital projects. On the other hand, there are corporates that are way too conservative and prioritize capital return over capital investment, and this leads to a failure to capitalize on value-accretive investment opportunities. Fortunately, GIL doesn't fall into either category.

In the five years between 2018 and 2022, GIL returned approximately $1.8 billion of capital to the company's shareholders via both dividends and share repurchases. This works out to be an average of $360 million of capital return on a yearly basis. Assuming that Gildan Activewear continues to distribute $360 million in excess capital to its shareholders every year going forward, GIL's estimated forward shareholder yield is a pretty attractive 6.7% based on its current market capitalization of roughly $5.4 billion.

Notably, Gildan Activewear isn't just focused on shareholder capital return. GIL understands the need to manage its financial risks through deleveraging, and it is also always on the lookout for M&A deals that can enhance shareholder value.

At its Q1 2023 earnings briefing in May, Gildan Activewear emphasized that its "net debt-to-EBITDA leverage ratio of 1.6x" as of March 31, 2023 was well within its "1 to 2x leverage" target.

Separately, GIL has made acquisitions wisely. The company's most significant M&A deal in recent years was the takeover of yarn producer Frontier Yarns in 2021 which allowed it to further vertically integrate across the supply chain. Gildan Activewear chose to purchase a key production asset which has cost synergies, rather than acquire competitors or rivals solely for revenue base expansion.

As per the points highlighted above, it is reasonable to conclude that Gildan Activewear has performed well in terms of capital allocation.

GIL Can Maintain High Operating Margins

At the company's 2023 Annual General Meeting of Shareholders on May 4 this year, GIL disclosed that its headline GAAP and adjusted non-GAAP operating margins were 19% and 20%, respectively. Gildan Activewear stressed at its shareholders' meeting this year that its 2022 operating margins were "at the high end of our 18% to 20% target range", which is mainly attributable to "efficiency gains."

Gildan Activewear's normalized operating profit margin contracted from 20.4% in Q1 2022 and 18.8% in Q4 2022 to just 14.6% for Q1 2023. GIL explained at its Q1 2023 results call that its operating profitability in the most recent quarterly was negatively impacted by the "unfavorable mix impact of the lower fleece sales." Nevertheless, GIL is guiding for a +1.0-1.5 percentage points QoQ expansion in operating margin in Q2 2023 and a 18%-20% operating margin in full-year FY 2023.

If Gildan Activewear meets its full-year operating profitability guidance in the current year, FY 2023 will represent the third consecutive year that the company has managed to deliver operating margins in the 18%-20% range as per its targets. Looking ahead, the market's current consensus FY 2024-2027 normalized operating margin estimates for GIL are in the 18.2%-19.6% range, which is within the company's operating profitability goals.

I am confident in Gildan Activewear's ability to continue delivering high operating profit margins for FY 2023. GIL's weak Q1 2023 operating margin was due to lower than expected high-margin fleece sales. Distributors had held back on buying fleece in the first quarter of this year, but GIL's point-of-sales data suggest that purchases and shipments of fleece are expected to pick up in the rest of 2023. At the company's first quarter earnings briefing, GIL also cited favorable factors like production efficiencies, lower cotton prices, and higher selling prices as supportive of its margin recovery in subsequent quarters of the year.

Undemanding Valuations For Gildan Activewear

Gildan Activewear is valued by the market at 9.9 times (source: S&P Capital IQ) consensus forward next twelve months' normalized P/E now. In comparison, the current consensus FY 2024-2027 normalized EPS CAGR for GIL is +11.2%.

In other words, GIL's Price/Earnings-to-Growth or PEG valuation multiple is 0.88 times or below 1. This implies that Gildan Activewear's shares are currently undervalued.

Concluding Thoughts

I am of the view that Gildan Activewear is a good investment candidate worthy of a Buy rating. I have considered GIL's capital allocation strategy, its profitability outlook and valuations in making this bullish assessment of the company's shares.

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