Steel City Capital is Bullish on Gildan (GIL) and Five Below (FIVE)

Steel City Capital Investments, LLC is the management company of the Steel City Capital fund. Michael G. Hacke is the fund’s founder and managing member. Recently, Steel City Capital released its Q1 2020 Investor Letter – a copy of which can be downloaded here. For Q1 2020, the fund reported a net return of -10.7%, while the S&P 500 returned -20.00%.

In the said letter, Michael G. Hacke spoke about Gildan Activewear Inc (NYSE:GIL) and Five Below Inc (NASDAQ:FIVE) stocks. Gildan Activewear is a clothing company. Five Below engages in the operation of shopping center. FIVE operates through the following segments: Leisure, Party and Snack, and Fashion and Home. Here is what Michael G. Hacke said:

“The Partnership initiated new positions in Gildan (GIL) and Five Below (FIVE) during the quarter. From a qualitative perspective, the investments have no descriptive overlap. From a quantitative perspective, I was drawn to both by their attractive financial characteristics and bargain basement valuations.

FIVE is a rapidly growing brick-and-mortar retailer that – as its name suggests – sells a variety of merchandise priced at $5 and below. It largely targets the teen/tween demographic and sells products across a wide variety of categories including toys and games, technology, beauty and style, candy and snacks, as well as seasonal/holiday centric merchandise. The company has boasted an attractive financial profile: annual sales growth of 20%, a five-year EPS CAGR of 25%, returns on equity north of 20% with no debt, and robust free cash flow generation. The company has a meaningful growth runway ahead of it as it expands its footprint westward and infills existing markets. There also remains levers to improve same store sales growth through remodels, the introduction of a rewards program (enabling customer data collection), increased marketing and brand awareness, and the eventual rollout of a “Ten Below” concept within existing stores (boosting average ticket). The near-term outlook has been clouded by a combination of increasing tariffs on imported goods, and more significantly, fallout from the coronavirus. All of FIVE’s stores are currently closed.

GIL manufactures everyday basic apparel including activewear (t-shirts and sweatshirts), as well as underwear, socks, and hosiery. The company’s bread-and-butter is the activewear business, where GIL primarily sells blank, undecorated shirts to screen printers (via wholesalers) who decorate the product with designs and logos, and in turn sell the decorated product to educational institutions, athletic dealers, promotional product distributors, charitable organizations, and various other retailers. GIL’s activewear business constituted ~$2.2 billion, or 80%, of the company’s FY’19 sales. The balance of sales are generated from the sale of underwear, socks, and hosiery. Here the company has increasingly abandoned the sale of its own branded products in favor of manufacturing private label products on behalf of third-parties. For example, GIL provides contract manufacturing services to Wal-Mart for its George brand as well as Costco’s Kirkland branded underwear.

GIL’s P&L has faced some headwinds in recent years as management closed higher cost manufacturing operations, consolidated production in lower cost markets, and took write-downs of its slower moving inventory. Looking through these items, GIL has enjoyed a relatively stable earnings profile with mid-teens returns on equity. I anticipate that such charges will begin to recede in the coming years, improving the company’s return profile and free cash flow generation. Over the longer term, earnings could benefit from the company’s planned international expansion (it is currently expanding its manufacturing facilities in Bangladesh) as well as targeted cost savings which are expected to materialize as a result of the aforementioned manufacturing facility consolidation.

What ties the two opportunities together is the Partnership’s entrance at valuations significantly below long-term averages. In the case of FIVE, shares quickly traded to 15x earnings, approximately half the company’s five-year average of 31x. Similarly, GIL traded as low as 5.5x earnings, approximately one-third of the company’s five-year average of 16x. In neither case did I catch the exact bottom, but that shouldn’t distract from the fact that the purchases represent a veritable steal. In both cases, we were able to establish a position at valuations more than two standard deviations below their five-year averages. Be fearful when others are greedy, and be greedy when others are fearful. Of course, it’s a near certainty that neither FIVE nor GIL will generate earnings in 2020 anywhere close to what was expected in a pre-coronavirus world, but that’s no matter to me. If you invest in the present, you’re going to get run over.”

In Q4 2019, the number of bullish hedge fund positions on GIL stock increased by about 10% from the previous quarter (see the chart here).

In Q4 2019, the number of bullish hedge fund positions on FIVE stock increased by about 14% from the previous quarter (see the chart here).

Disclosure: None. This article is originally published at Insider Monkey.