Why You Need Underwear in Your Portfolio

Almost everyone wears underwear on a daily basis. With over 300 million people in the U.S., that's a huge market. Hands down, the best company to invest in for exposure to this large market is Hanesbrands . The company's products include various undergarments, with key brands like Hanes, Champion, and Wonderbra.

Why Hanesbrands is so appealing
Hanesbrands has the largest market share in almost all major essentials categories. This includes t-shirts, socks, men's underwear, hosiery, and children's underwear. It's number two in market share for bras and panties.

Hanesbrands is very compelling from an investment perspective. It could be a buyout candidate, given its leading market share in various undergarments. It would fit nicely in an overseas company's portfolio if the company looked to gain access to the U.S. undergarment market. About 90% of Hanesbrands' sales are in the U.S., with the other 10% coming from the international segment.

A private equity firm could also be a suitor for Hanesbrands because of its very strong free cash flow. Private equity firms love companies that generate high cash flow. Even still, the company will do just fine if it remains a public company. It can continue to leverage its free cash flow to be an industry consolidator. Earlier this year, Hanesbrands CEO Richard Noll said during an investor presentation,

there can be other things such as that [referencing Hanesbrand's 2010 Gear acquisition], that's in our core categories that we can use to leverage our global supply chain, reduce cost and justify any premium that we may pay. And we'd also have a goal in mind of any type of acquisition where it would be relatively quickly accretive.

Well, they appear to have found such an acquisition, as earlier this year Hanesbrands bought Maidenform for $550 million. The Maidenform acquisition is expected to be accretive to Hanesbrand's earnings in the first 12 months, ultimately adding $0.60 to EPS per year within three years.

Hanesbrands has a lot of potential. But that's only the half of it, as the company is firing on all cylinders operationally.

Strengthening fundamentals
Hanesbrands is seeing positive momentum from its "Innovate to Elevate" initiative. This strategy focuses on higher-priced, higher-margin items. Operating margins are now at decade highs. Lower cotton prices have also helped drive margins higher. After a huge spike in cotton prices in 2011, we're beginning to see more normalized prices. This benefits Hanesbrands because the majority of its products are 100% cotton.

Maidenform is another move to offer higher-priced, higher-margin products. Maidenform's brands include Flexees, Self Expressions and Sweet Nothings. The other positive? Maidenform has a stronghold on the younger generation (such as Generation-Y), which is one of the largest consumer bases of the economy.

The underwear and undergarment segment also has a "sticky" customer, in that there is a degree of brand loyalty. What's more is that undergarments are generally not a consumer discretionary item, and they require periodic replacement.

One of a kind
There's no company quite like Hanesbrands. You can get exposure to the underwear market via the likes of Ralph Lauren and PVH, but the underwear segments make up a small part of their businesses. Hanesbrands also offers products across the entire price spectrum. With men's underwear that ranges from $8 to $40, the company literally has something for everyone.

Hanesbrands sells its products in the United States' two largest discount retailers, Wal-Mart and Target . About 28% of sales are made to Wal-Mart and 18% to Target. Hanesbrands' partnership with these two retailers gives it the ability to reach a very broad and diverse customer base (Wal-Mart has over 4,000 U.S. stores and Target 1,700). Hanesbrands also started selling its products in Macy's this June, which should go a long way towards helping the company grab more market share.

Positive performance from Wal-Mart and Target should translate into positive performance for Hanesbrands. Analysts expect earnings per share to grow at an annualized 9% and 10.5% for Wal-Mart and Target, respectively, over the next five years. Helping drive more traffic at Target should be the company's continued rollout of its P-Fresh model, which includes offering groceries and consumables in its stores. Meanwhile, the one weak spot for Wal-Mart is that dollar stores cut into its market share during the financial crisis. As the economy rebounds, Wal-Mart should recapture some of those customers because it is a one-stop shop for almost all consumables.

Bottom line
With a $7.5 billion enterprise value and market leadership, Hanesbrands could easily become a buyout candidate. The ultimate worry would be that the company was already trading at a buyout premium, but that doesn't appear to be the case. The stock trades at 14 times 2014 earnings estimates, which is still relatively cheap when you compare it to the industry average. The apparel industry trades at an average 17.7 times forward P/E.

If anything, the stock's still undervalued. Regardless of whether or not a buyout materializes, the company has solid positioning in the underwear market that makes it a must-own.

Hanesbrands isn't the only great company the Fool loves
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The article Why You Need Underwear in Your Portfolio originally appeared on Fool.com.

Marshall Hargrave has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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