July 01, 2020 - 12:03am EST by
2020 2021
Price: 12.12 EPS 0 0
Shares Out. (in M): 7 P/E 0 0
Market Cap (in $M): 86 P/FCF 0 0
Net Debt (in $M): 140 EBIT 0 0
TEV (in $M): 226 TEV/EBIT 0 0

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Delta Apparel, Inc. (DLA) was kicked out of the Russell 2000 on Friday, June 26th.  Being a microcap apparel wholesaler during C-19 isn’t fun, but the selling pressure from the approximately 700,000 shares sold for the Russell 2000 rebalance leaves DLA at $12.12/sh, down 61.0% YTD.  Fair value is ~250% higher than the current price (where it traded six months ago) and if the market doesn’t recognize this value, management will sell part, or all, of the company.



In FY2019, DLA had revenue of $431.7 million, EBITDA of $29.2mm, EBIT of $17.4mm, and EPS of $1.37.  DLA reports two segments: Delta Group and Salt Life.  The Delta Group segment generated $389.1mm of revenue, with approximately $60mm from DTG2Go, which is detailed below.  Salt Life revenue was $42.7mm.  Delta Group EBITDA was $33.7mm and Salt Life was $7.7mm - unallocated corporate expenses make up the difference to consolidated.

Having met the CEO & CFO once or twice a year for the past several years at conferences, we believe now is the opportune time to invest.  First, because their stock price is depressed.  Second, because DTG2Go has grown to a size and scale where it can be analyzed and valued.  And the value of DTG2Go is the entire EV.  Third, the management team is flabbergasted with the share price and our industry work confirms management’s hinting that the business can be monetized for far above the current price.

So what’s the catch?  The market cap is $85.5mm and outside of a day like the R2000 rebalance, average daily value traded is $250-750k.  And specific to the business, there is debt (more below) and the core business of making apparel is weak given C-19/global recession (again, more below). 

Fiscal year-end is Sept 30, so as of Q2 (Mar 31), net debt is $158.3mm, which optically is nearly double the market cap.  In the valuation, we use the average debt of the past four quarters given the seasonality of building inventory in advance of peak fall and winter selling, which is why it does not tie.  Offsetting the debt is $200.0mm of net working capital (AR + Inv - AP).  While an unfortunate aspect of the business is the need to hold a lot of inventory, the debt is well covered.  Also, while every apparel company needs to be concerned about inventory write-offs, as these as standard apparel products (i.e., a tee shirt that Under Armour will print their logo on) there is little risk of an inventory obsolescence charge.  For additional detail, on the Q2 conference call CFO Deb Merrill explained her comfort with DLA’s debt position and we’ve spoken with her one-on-one to gain further comfort.  We agree that the debt isn’t a concern and CFO Merrill is adamant that DLA has plenty of liquidity in draconian scenarios (far worse than they’re seeing).  She has explicitly stated that DLA will not issue any form of equity (i.e., no common, no convert, no warrants).  Lastly, while no one values an apparel maker on P/B, there’s material shareholders equity, which is another reason to feel comfortable with the debt level: $22.37/sh of BV and $13.86/sh of TBV.

Like other apparel makers, DLA’s apparel wholesale business has taken a dramatic hit from C-19.  The company hasn’t guided to FYQ3 revenue, but it will likely drop 50%+ as manufacturing plants were closed for a good portion of the quarter.  However, it should rebound relatively quickly.  While the 15% of apparel wholesale product sold through department stores won’t see a near-term rebound, 60% is sold through mass merchants such as WMT/TGT.  The company has confirmed that after an air pocket, mass merchants are re-ordering.  

We don’t believe it’s worthwhile to spend a lot of time on FYQ3 as it’s going to be bad for almost all apparel/retail companies, but Telsey Advisory Group covers DLA and predicts FYQ3 will see a yoy revenue decline of about 60% and EBITDA of -$4.3mm.  Negative EBITDA isn’t good, but Telsey forecasts FYQ4 EBITDA rebounding to $4.4mm.  Forecasting profitability is quite difficult at the current time, but our work and conversations with the CFO lead us to slightly better FYQ4 results than Telsey is forecasting.  But as detailed below, the upside is so large that one shouldn’t get mired in trying to forecast if quarterly results can beat sellside estimates. 

The business reports under two segments: Delta Group (90% of FY19 rev) and Salt Life (10% of FY19 rev).  Salt Life is a beach-oriented brand that is growing nicely.  DLA bought Salt Life in August 2013 as Salt Life used Delta for production so DLA was aware of Salt Life’s growth profile.  Since the acquisition, revenue has doubled and at the ICR conference in January, the CEO hinted it’s likely time to sell.  A sale of Salt Life is off the table in the near term, but it’s a potential catalyst and similar brands, such as Southern Tide have been sold to larger apparel companies (OXM was the buyer).  The CEO’s rationale for divesting Salt Life was that while the growth profile continues to be double digits, given the opportunity the company sees in DTG2Go, it may be wise to focus DLA’s efforts. 

There are two interesting aspects of the Delta Group segment.  First, Delta manufacturers activewear and maintains inventory exclusively in North America so the company is a beneficiary as customers look to shorten supply chains and move production out of China.  While difficult to quantify the benefit, the company has noted increased interest in Delta Group’s manufacturing plants as current, and potential, customers look to shorten their supply chains.  Second, DTG2Go provides on-demand virtual inventory through digital print, which is a rapidly growing market and DTG2Go is the market leader.  DLA rolled up the top three providers of digital print services, invested in the latest & greatest technology (e.g., only DTG2Go can print on polyester), and integrated with the rest of their apparel business.  The result is that product can be shipped in two days or less to 99% of the country.  To give an example, if a retailer wants to show a product on its website, but doesn’t want to hold the inventory, the retailer can integrate with DTG2Go so that when the order comes in, DTG2Go seamlessly creates the product and ships it to the end customer.  The end customer does not realize that the product came directly from DTG2Go.  The only competitor with a similar offering is Amazon, but there isn’t competition between DTG2Go and Amazon.  This is because retailers recognize that giving this type of integration to Amazon results in Amazon understanding the retailer’s business model and having the retailer’s customer list. 


Importantly, DTG2Go’s growth profile has been strengthened by C-19.  The management team discussed this on the Q2 conference call and this has continued in FYQ3 as DTG2Go had Apr yoy revenue growth of 25% and May accelerated to 32%.  DTG2Go is the highest margin business at DLA and the business segment deserving of the highest valuation.  DLA has given soft guidance for DTG2Go reaching $100mm of FY2022 revenue.  In our discussion with CFO Merrill, she noted that C-19 has accelerated DTG2Go’s business and is increasingly confident in achieving $100m of FY2022 revenue, a two year increase of approximately 50% from FY2020E DTG2Go revenue of $65-70mm.  The company IR presentation notes that DTG2Go’s EBITDA is 20%+ and in our analysis and discussions with Deb Merrill, we believe 30% is achievable in FY2022 due to increased operating leverage.  Below, our valuation uses 25% to be conservative. 

While management has stated that monetizing Salt Life is something they have considered in the past and will continue to review, they believe that either the market needs to recognize the value of DTG2Go or they need to take action.  DTG2Go’s ~20% revenue growth and strong margins are quite valuable and would attract many buyers.  But mostly importantly, our work indicates that large apparel retailers would love to own DTG2Go.  To highlight the most obvious example, Walmart is aggressively working to counter Amazon, but does not have its own digital print platform.  

As a sanity check, we thought that FY2021 (Sept yr-end) EPS would be $2.00 or higher.  So six month ago, DLA was valued at ~15x forward P/E.  While the timing has been pushed to the right by C-19, we don’t believe that $2.00/sh of EPS is off the table.  At ~6x $2.00 of EPS, DLA is just too cheap given the growth/margins of DTG2Go and management’s desire to improve the share price.


Lastly, in case it’s not clear from the writeup, we think that this management team is far above average in microcaps/smallcaps.  The management/board own approximately 10% - please note that sales earlier in 2020 were from the CEO’s ex-wife, not the CEO himself.  CFO Deb Merrill is the primary investor contact – she is very good and we suggest speaking with her.  

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Sale of Salt Life or DTG2Go

Continued strong growth of DTG2Go

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