May 9, 2021

Delta Apparel Is At The Start Of A Significant Positive Inflection, With Near-Term Catalysts (NYSEMKT:DLA)

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Thesis

I believe Delta Apparel, Inc. (DLA) will increase dramatically, with upside potential of $45+, due to imminent catalysts and the stock’s tremendous undervaluation. There are also many catalysts that I expect to drive an upward revaluation, most imminently DLA’s next earnings report (expected in November) which I project to be tremendously above consensus (one analyst) expectations. There has been the perfect storm of positive events that have occurred for DLA, yet the stock has barely reacted, and is near multi-year lows.

DLA is a high-growth technology and apparel company being undervalued by the market, because it is a small-cap in the apparel retail sector. DLA is one of the primary beneficiaries of Covid, due to its DTG2Go subsidiary, which is growing 50%, and should approach $95M in sales and $21M in EBITDA in FY21. DTG2Go is the only large-scale vertically integrated provider of digitally printed apparel, with the ability to manufacture and ship products to consumer and wholesale clients within 24-48 hours. The DTG2go technology and process are highly proprietary, and is used seamlessly within the systems and websites of DLA’s retail customers (including WMT and TGT), to enable them to lower costs (no inventory), increase delivery speed, and increase SKUs at no extra costs on their websites.

I estimate DTG2Go alone is currently worth at least $30 per share, and if the market does not recognize the value, DLA will spin off or sell this subsidiary. DLA’s other subsidiaries are also growing, including its lifestyle clothing brands Salt Life and Cost ($43M FY19 revenues), and the company’s other wholesale and direct clothing businesses, Soffe and Delta Activewear ($329M in FY19 revenues).

Valuation

DLA is among the most undervalued stocks I have seen in over 30 years of investing. DLA is valued at an adjusted 2020 P/E, EV/EBITDA, and FCF yield of 15.4x, 5.6x and 14%, based on my estimates. DLA is valued at a 2021 adjusted P/E, EV/EBITDA and FCF yield of 6.8x, 4.9x and 32%, based on my estimates. My short-term target price for the stock is about $45 per share, which equals an adjusted FY21, P/E, EV/EBITDA, and FCF yield, of 21x, 9.2x, and 10%, resulting in 200%+ short-term return potential.

Why does this opportunity exist?

The dramatic undervaluation for DLA exists for several reasons;

1) DLA is an underfollowed micro-cap which is not well known, and has no direct comps.

2) DLA operates within the apparel and retail spaces, both of which are unloved by investors.

3) DLA was initially impacted negatively from Covid, and recently reported weak FY3Q results (DLA reports on a September fiscal year) with revenues down 40% YOY, and one-time Covid costs of $23.1 mil ($11 mil were non-cash). However, what the market seems to have missed is that the initial Covid impact was purely from the disruptions and reconfigurations caused in the initial stage of the shut-down, when the company was forced to shut some of its manufacturing plants and stores. Since that time, the impact of Covid has turned positive, and DLA has returned to YOY growth. In fact, Covid is now driving accelerated growth for DLA due to the growth in digital printing and e-commerce, and the change in consumer preferences towards casual/activewear apparel.

Imminent Catalysts

The most imminent catalyst is when the company reports FY4Q results in November, and gives an outlook for FY21. I expect the company to absolutely blow away FY4Q consensus revenue and adjusted EPS estimates of $84.7 mil and ($0.06)*, and report $118.8 mil and adjusted EPS of $0.44. Furthermore, I expect DLA to give a very positive feel for FY21 expectations resulting in adjusted EPS estimates of above $2.00 a share.

My above consensus estimates are simply based on DLA’s recent statements in its 3QEPS report and after, which the market has completely ignored because it was focused on the poor headline EPS number. In DLA’s F3QEPS released on July 30, its CEO commented,

“We are thrilled with the momentum experienced across our business segments as the U.S. economy and our customers re-opened for business. With net sales in June tracking at nearly 90% of prior year levels and with further acceleration in July, we are very encouraged by the steep recovery in recent weeks that exceeded our internal expectations. Our DTG2Go business on boarded several new customers and received additional digital print volume from existing customers to deliver over 30% net sales growth for the quarter compared to prior year. In addition, our Catalog and Salt Life businesses returned to growth in June”.

Twelve days later DLA put out another press release, on August 11, titled “Delta Apparel Returns to Growth in July,” which further stated,

“Delta Apparel’s net sales in July grew over 10% compared to the prior year period, with growth in each of its business units.” The company’s CEO noted, “The start to our fourth quarter has exceeded our expectations with July double-digit net sales growth. This marked our fourth consecutive month of sequential sales improvement. We are particularly pleased to see a return to growth across all business units, with notable strength in our DTG2Go digital print business achieving an over 50% sales increase year over year. Our strong July performance further strengthens our commitment to return to fourth quarter profitability, on both a reported and adjusted basis. Our teams are working hard to satisfy the broad-based demand we are seeing in the market.”

It is clear from DLA’s latest press release that the company is benefiting tremendously from the aftermath of Covid, and is in the best position in its history as a public company.

The Company

Delta Apparel’s 10k states that the company “is a vertically-integrated, international apparel company. With approximately 8,500 employees, we design, manufacture, source, and market a diverse portfolio of core activewear and lifestyle apparel products under our primary brands of Salt Life, COAST, Soffe, and Delta. We are a market leader in the direct-to-garment digital print and fulfillment industry, bringing DTG2Go technology and innovation to the supply chain of our customers. We specialize in selling casual and athletic products through a variety of distribution channels and tiers including e-retailors, outdoor and sporting goods retailers, independent and specialty stores, department stores and mid-tier retailers, and mass merchants. Our products are also available direct-to-consumer on our websites and in our branded retail stores.”

DLA has two divisions, and 5 subsidiaries under these divisions. Delta Group ($389M in FY19 sales), and Salt Life Group ($43M in FY19 sales). Delta Group is comprised of 3 subsidiaries, including DTG2Go, Soffe, and Delta Activewear. I am spending most of this report focusing on DTG2Go, because this subsidiary is the crown Jewel of DLA, and I estimate it is worth about $30 per share, today. However, the rest of DLA’s subsidiaries are in very healthy condition and are growing. Salt Life Group is growing particularly strongly, as this brand gains significant traction in the Covid environment, with revenues up 23% YOY in July. The link to DLA’s latest company presentation is here.

DTG2Go

DTG2Go is the crown jewel of the company. DLA’s 10k states that DTG2Go is

“a market leader in the direct-to-garment digital print and fulfillment industry, bringing technology and innovation to the supply chain of our many customers. We use highly-automated factory processes and our proprietary software to deliver on-demand, digitally printed apparel direct to consumers on behalf of our customer,” using proprietary technology and trade secrets. “Utilizing its seven fulfillment facilities throughout the United States, DTG2Go offers a robust digital supply chain to ship custom graphic products within 24-48 hours to consumers in the United States and to over 100 countries worldwide. DTG2Go services the fast-growing e-retailer channels, as well as the ad-specialty, promotional products, screen print, traditional retail, social media, and licensed apparel marketplaces, among others.”

DTG2Go has grown its revenues from $10M in FY14 to an expectation of $70M+ this year. DTG2Go’s growth has accelerated since Covid, and grew 50% YOY in July. The primary drivers of DTG2Go’s growth include the subsidiary’s revolutionary business model, a growing market for digitally printed clothing, the lack of any competition with similar capabilities, and Covid which has been causing more customers to adopt DTG2Go’s solutions and has pushed consumer preferences towards casual/activewear attire.

DTG2Go is positioned to grow tremendously over the short and long term due to its revolutionary business model, the expected growth in digital printing on apparel, the lack of viable competition, and the shift in consumer preferences. DTG2go is the only vertically integrated digital printing provider I am aware of that has the ability to ship high-volume, high-quality product directly to consumers within 24-48 hours. DTG2Go’s proprietary software and logistics system enable it to seamlessly integrate with any of its customer’s websites (such as TGT and WMT), and for digitally printed apparel to be manufactured upon purchase, and shipped within 24-48 hours directly to the customer without them knowing DLA had anything to do with the process. This model is simply a better mousetrap for virtually any retailer, enabling them to lower costs, eliminate holding inventory, increase selection, and quicken delivery times. Imagine how much more money a retailer could make if it could multiply the selection of printed apparel it offers on its website at no additional cost, and with no inventory? Also imagine how much money a retailer could save by almost never having to write down this type of inventory again? DTG2Go’s platform allows them to do both – no-brainer. This platform can also give e-retailors future capabilities such as allowing consumers to customize their own clothing, which many say is a coming trend.

DTG2Go’s market opportunity is huge, and has barely entered its first inning of growth. Digital impressions only make up about 2% of total graphic impressions on clothing according to the company. DLA believes the digital impression market could grow over 400% in the coming years, to 10% of graphic impressions on clothing. Other commentators expect even greater penetration of digital printing. Given the tremendous advantages of digital printing for many applications versus traditional screen printing, it seems highly likely that rapid growth of 30%+ will continue into the foreseeable future. Many industry participants expect digital printing to eventually comprise 50%+ of the graphic impressions market due to its superior cost and selection characteristics. It is also important to note that digital printing is generally environmentally superior versus screen printing, because of the cleaner water-based ink used in the digital process.

I believe DTG2Go is currently worth at least $30 per share, with significant upside in a sale, or spin scenario, which management is considering. I derive my $30 value for DTG2Go by applying a 10x EBITDA multiple on my 2021 EBITDA estimate of $21M, which equals $210M of value or $30 per share. In discussions with bankers, I believe DTG2Go could be valued at a 15x EBITDA multiple in a sale or spin scenario, which equals $315M or $46 per share. While looking at valuation, it is important to note that if digital impressions market grows to 10% of the overall graphic impressions market, DTG2Go could report revenues in the $350M range. DTG2Go also has very strong EBITDA margins in the 22% range, resulting in EBITDA potential of $77M in the coming years. DTG2Go is also a potential acquisition target of many etailers and retailers including AMZN, FB, EBAY, WMT and TGT, among others.

Delta Activewear: The company’s 10k states, “Delta Activewear has been a preferred supplier to the market for core basic tee shirts for many years.”

Soffe: The company’s 10k states, “Soffe is an iconic, heritage brand that designs and produces high quality activewear for spirit makers and record breakers. Soffe sells a wide range of activewear products for women, men, juniors and children with appealing graphics anchored in today’s trends.”

Salt Life Group: According to DLA’s 10K, “The Salt Life Group is comprised of our lifestyle brands focused on a broad range of apparel garments, headwear and related accessories to meet consumer preferences and fashion trends, and includes our Salt Life and Coast business units.”

Income Statement

Using relatively conservative assumptions, I estimate DLA will report FY21 revenues and adjusted EPS of $478M, and $2.17, versus consensus estimates of $412M and $1.03. Consensus estimates have mistakenly not increased since DLA’s August 11th press release indicating very strong above-expectations growth (link below) across all business segments, with aggregate sales growth of 10% in July. My FY21 EPS and revenue estimates simply assume a continuation of 10% growth throughout the year above pre-Covid revenues, and slightly expanding margins, because most of the growth is coming from DLA’s highest margin divisions, DTG2Go and Salt Life.

Here is the press release indicating strong results: Delta Apparel Returns to Growth in July :: Delta Apparel, Inc.

Balance Sheet and Cash Flow: DLA’s balance sheet is deceptively strong, and I expect the company to generate tremendous adjusted FCF in 2021 and beyond. I project DLA will generate FY21 FCF of $33M, which equates to a 33% FCF yield. To note, my adjustments assume flat working capital, and in reality, as revenue growth continues to accelerate, we are likely to also see growth in inventory. The $33M of FCF is thus illustrative of what DLA would achieve in a flat revenue growth environment at the projected FY21 revenue base.

Catalysts

There are several catalysts for DLA including the following: 1) My expectations that DLA will report significantly above consensus 4QEPS results, and FY21 guidance in November. I would not be surprised if the company pre-announced at some point; 2) The potential spin-off or sale of the company’s D2G2go subsidiary, which would unlock tremendous value; 3) Potential sale of the entire company, because DLA would make a perfect tuck-in acquisition for many on-line and traditional retailers; 4) The potential that investors begin to better understand the company, and revalue it as a high-growth company.

Risks

Key risks include the potential for spikes in Covid to cause closure of DLA’s manufacturing facilities and potential for write-downs associated with DLA’s traditional retail exposure. However, any manufacturing closure would be a short-term event, and DLA already has taken all likely write-downs when the company reported last quarter, and I don’t believe any additional write-downs would be meaningful enough to impact my thesis.

Conclusion

DLA is on the verge of dramatic positive inflection in its growth profile, driven by its innovative business model, and changing consumer preferences, which should last for the foreseeable future. The stock market has missed DLA’s recent positive news, due to lack of investor attention, leaving the stock dramatically undervalued. There is an imminent catalyst when DLA reports FY4Q results in November, which I project will be significantly above expectations. If the stock market does not recognize the value of DLA soon, I believe the management will spin or sell the company’s DTG2go subsidiary.

Disclosure: I am/we are long DLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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