DELTA APPAREL INC DLA
November 04, 2013 - 9:43pm EST by
elke528
2013 2014
Price: 17.72 EPS $1.13 $2.05
Shares Out. (in M): 8 P/E 15.7x 8.6x
Market Cap (in $M): 143 P/FCF 5.9x 7.1x
Net Debt (in $M): 135 EBIT 14 28
TEV ($): 277 TEV/EBIT 19.9x 10.0x

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Description

Delta Apparel (“DLA”) offers the opportunity to invest in a well-managed, growing portfolio of apparel brands and textile operations trading at 9x P/E (FY14) and 14% FCF yield.  DLA is working on a number of initiatives that should lead to continued growth in the next several years with significant cash flow generation.

DLA is a designer, manufacturer, and distributor of apparel products (largely t-shirts) across the screenprinting and retail value chains.  DLA makes basic t-shirts that are sold directly to screenprinters and private label apparel sold to sportswear companies.  These comprise the Basics Segment, which are about 55% of revenues.  The remaining revenues come from the Branded Segment which consists of a number of brands and specialty operations including:

  • Soffe (~$90m revenues), which is most well-known for cheerleading clothes, but also sells a couple of other brands through the U.S. military and other retailers.
  • Junk Food (~$70m revenues), which is best known for vintage-looking t-shirts at high-end department stores.
  • The Game (~$60m revenues), which is best known for distinct styles of baseball caps for college sports fans.  They also produce a variety of licensed apparel sold through college bookstores.
  • Art Gun (~$20m revenues), which provides back office fulfillment for websites that give consumers the ability to design their own t-shirts. 
  • Salt Life (~$20m revenues), a brand with a loyal following among fishermen, surfers, and boaters, especially in Florida.  After licensing the Salt Life brand for two years, DLA was just acquired the brand in August.

Why does this opportunity exist?

  • Delta is easily perceived as a disadvantaged also-ran:  Delta is overlooked as a small and disadvantaged competitor to large competitors in the commodity screenprint t-shirt business.  While they overlap with Gildan and Fruit of the Loom for 35% of their business, they are not as disadvantaged as meets the eye.
  • Lack of analyst coverage:  Roth Capital and Sidoti are the only listed brokerage firms that cover DLA. 
  • Lots of moving parts:  DLA is going through a stabilization period for its largest brand, Soffe, which lost significant business from Kohl’s and JC Penney in 2012-2013.  Finally, consumer demand at retail recently has been weak.

There is no doubt that DLA participates in a tough space, but this management team has pulled off revenue growth either through organic initiatives or acquisitions (8 acquisitions since 2003) for the past 10 years.

The printwear segment for t-shirts (blank t-shirts, usually used for promotional products or local events) is largely a commodity segment, but DLA has carved out a niche where they can compete.  Unlike Gildan or Fruit of the Loom, which collectively have about 90% market share and sell through distributors, DLA’s go-to-market strategy is direct to screenprinters.  While DLA could never compete with Gildan or Fruit head-to-head because of scale, without another middleman taking a margin in the chain, they can compete.  As a result, DLA sells a lot to regional players or other large screenprinters who produce products for large retailers.  If you go into Wal-Mart’s clothing department and notice a tall display with many t-shirts designs on shelves, many of those are printed on DLA shirts.  With that focus, DLA has actually grown the Basics Segment every year since 2009 at an average rate of 6.4%.  While company-specific initiatives have an impact, underlying market growth is driven by GDP growth.

The Branded Segment, however, is more driven by marketing initiatives and design.  Soffe is in the midst of a turnaround after some retailers pulled away from the brand to increase their own private labels.  After a 25% drop in revenues from FY11 to FY13, Soffe had a $7m operating loss last year.  That business has now stabilized and they expect break-even performance this year.  With a new leader in place, we should start to see some improvement.

Notwithstanding the challenges at Soffe, all of DLA’s other brands have been growing well and show promise.  For example, Junk Food has built its own consumer label, which has led to significant growth in higher-profit e-commerce.  The Game recently started an “American Threads” label for college bookstores, which appeals to college students’ desire to buy American.  As a Salt Life licensee for the past two years, DLA has taken the Salt Life brand from one market in Florida to over 1,500 retail outlets.  Finally, Art Gun’s success in web-based technology and efficient t-shirt design fulfillment is most evident in Society6, an Art Gun client, which was purchased by Demand Media (DMD) in June for $94m or 6.3x revenues or 23.5 EBIT (based on 2012 figures, the only ones that were disclosed).

Through a combination of steady growth in the Basics Segment and continued execution (assuming stabilization of Soffe) in the Branded Segment, revenues should continue to grow at a low to mid-single-digit clip.  Regarding margins, EBITDA margin has been pressured over the past several years, ranging from weaker demand, the decline at Soffe, and multiple operating systems.  Recently, though, DLA has integrated into a new ERP system, expanded manufacturing operations in Honduras, and upgraded printing operations for Soffe in North Carolina with more efficient equipment.  This should help improve margins, likely by 200 bps or more.  Margins should also improve in 2014 with the acquisition of Salt Life.  They had been paying a royalty payment to Salt Life on that brand’s apparel.  Now that they own the IP, they not only will not have to pay the royalty, they will receive royalty payments on other product lines, ranging from sunscreen to sunglasses.

DLA has high insider ownership and good governance.  Bob Humphries, the CEO, owns 5.6% of the company (and 9.5% including exercisable options).  He came to Delta Apparel with the spin-out of the company from Delta Woodside (an industrial conglomerate that split itself up in 1999).  He has over 25 years in the textile and apparel industry.  The company has decent stock ownership guidelines for senior management, and performance-based compensation is based primarily on return on capital employed (“ROCE”) metrics.  As an example, because the three-year compounded average EPS growth and ROCE came in below their targets, the management team received less than half of their target cash bonuses and forfeited significant equity compensation.

DLA is also aggressive and opportunistic in buying back its own stock.  Since FY01, DLA has repurchased 1.9m shares (or 19%), and they have been quite aggressive recently:  over the past 12 months, DLA has repurchased ~7% of diluted shares.  $7.9m remains authorized.

DLA’s balance sheet looks highly levered on an LTM basis, but that is just after the Salt Life acquisition, for which they got $22m of seller financing.  Based on 2014 EBITDA, Net Debt/EBITDA is a manageable 3.7x.

Valuation Summary:

FY14 guidance contemplates modest low-single-digit growth and ~250 bps of EBITDA margin improvement from the stabilization of Soffe, operational improvements, and the addition of higher margin Salt Life revenues under their ownership.  FY14 EPS should be ~$2.05 with FCF of $20m.  With some growth coming back from Soffe in FY15, expansion of their brands, and additional stock buybacks, we could see EPS higher than $2.50 and FCF of $25m.  With those kinds of figures, DLA should be trading above $26.  I don’t see DLA ever trading at a GIL-type multiple, but it should be able to continue to generate significant cash and drive earnings further.
 
Risks:
  • Continued consumer weakness places pressure on retail sell-through or demand for apparel.
  • Gildan getting more aggressive in its direct-to-screenprinter segments
  • Issues with their important license agreements (mostly relevant to Junk Food)
  • Political instability in Honduras, where they manufacture most of their products.
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

  • Stabilization in Soffe
  • Margin improvements from system consolidation and equipment upgrades
  • Additional accretive acquisitions
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