Value Investors Club / DESTINATION XL GROUP INC (DXLG)

Description

In 2012, the Company embarked on a journey to transition from the Casual Male XL format to

the DXL format. The larger format DXL stores carry 2,000 styles with a greater selection of higher

ticket items, compared to 600 styles carried by Casual Male XL stores. Mature DXL stores are

also more productive with $200 to $220 per sqft of sales, compared to $180 SPSF at Casual Male

XL stores. This higher productivity results in higher four-wall contribution margins of 25%

compared to 18% at Casual Male XL stores. Since 2012, the Company has opened 186 DXL stores

and 14 DXL outlets, and closed 270 Casual Male XL stores and 27 Casual Male outlets through lease

expirations or terminations. Total store count decreased by 100, while selling square feet increased

from 1.8 million sqft to 2.1 million sqft today.

I believe DXLG is an above-average retail business trading at a cheap valuation.

Above-average business

• Off-mall retailer: DXLG stores are located in destination shopping centers such as strip

malls, power centers and stand-alone locations, so they are not dependent on mall

traffic.

• Attractive IRR for new stores: each new store costs $400,000 to $500,000 to build out

after tenant allowances. A typical new store generates $150,000, $250,000, and

$310,000 of four-wall cash flow in year 1, 2 and 3 respectively as SPSF grows from $155

in year 1 to $195 in year 3. Payback period for a new store is 2.5 years, and five-year IRR

is north of 30%.

• Better online economics: retailers usually suffer greatly from 30% of online sales being

returned. In contrast, return rate at DXLG is only 8%. This is because the sourcing team

at DXLG works with suppliers (55% branded and 45% private label) to ensure that the

same size (say 48 inch waist) means the same thing across different brands. So when a

customer places an online order, he can be confident that the size will work for him.

• This sizing consistency has led to higher conversion rates and repeat purchases. 70% of

customers who visit a DXL store make a purchase, and 90% of those who make a

purchase intend to purchase again.

• Largest player with significant growth runway in a fragmented segment: the Company

has about 12% market share in the $3.5 to $4.0 billion men's big and tall apparel

segment. Based on a 2016 study, 6 out of 10 potential customers do not know DXL. The

Company thinks it can eventually operate 340 DXL stores and 60 DXL outlets, compared

to 202 and 14 existing today.

• Resilient gross margin: many retailers have experienced gross margin erosions due to

higher fulfillment costs and increasing pricing pressure. Since 2011, DXLG's merchandise

margins have fluctuated tightly between 59.6% and 60.2%.

• Positive comps: the Company guides 1% to 4% same store sales growth this year.

Cheap valuation

• This year, the Company decided to slow down new store growth to focus on digital

engagement. The decreased capex will generate plenty of free cash flow which will be

used to pay down debt and repurchase stock ($12 million program).

• The Company targets $37 million to $42 million of CFFO this year. It targets $8 million of

maintenance capital expenditures and $13.7 million of new store capex. Free cash flow

would be about $30 million before growth capex, and $17.5 million after. These

represent 26% yield and 15% yield on the market cap respectively.

• Next year, the Company only plans 5 store openings. I expect that the Company will

generate $19 million of FCF after growth capex in 2018 (this year's CFFO would benefit

from better inventory days which I do not count on recurring).

• DCF (2017-2022):

• For 2019 to 2022, I model 10 new store openings/year to reflect management's

commitment to the eventual goal of 340 DXL stores. In addition, I model 1 DXL outlet

opening/year, 16 Casual Male XL closings/year, and 3 Casual Male XL outlet

closings/year. At the end of 2022, the Company will have 276 DXL stores and 19 DXL

outlets. DXL concept would make up 95% of the Company's 2.3 million sqft of selling

space (built-out space, which includes break and storage rooms, is used to calculate

SPSF at the Company).

• 216 of the 276 DXL stores would be 5 years or older, compared to 32 of 192 at the end

of 2016. The maturity of DXL stores and thus increased portfolio productivity would

result in better EBITDA and free cash flow generation.

• For 2022, I model $210 SPSF for the 216 mature DXL stores. This represents 2.6% same

store growth from the productivity of the current fleet. I model $195 SPSF for the

remaining 60 stores. I model $180 SPSF for the non DXL formats. I model 60%

merchandise margin and occupancy cost per sqft inline with today.

These assumptions result in $41 million of EBITDA in 2022. In addition, due to 6 years

of free cash flow generation, the Company would have net cash of $40 million.

• Tailored Brands trade at 6.5x EBITDA. DXLG equity valued at 6x 2022 EBITDA would be

worth $283 million (including the 2022 year-end net cash), or $5.7/share. It requires a

15% discount rate to discount that $5.7/share to today's share price, which I think is too

harsh.

• A 8% discount rate on unlevered FCF and 6.0x terminal EBITDA multiple result in $228

million of enterprise value, and $157 million, or $3.2/share, of equity value.

Risks

• Leverage: the Company has $71 million of net debt, or roughly 2.6x this year's EBITDA.

o Mitigants: the Company will generate substantial free cash flow this year and

next. EBITDA will grow as the current store fleet matures. Fixed charge coverage

ratio covenant of 1.0x does not kick in when excess availability under the $125

million credit facility is less than $12.5 million. Currently there is $60 million

available under the credit facility, and I anticipate that liquidity will get stronger

as the Company generates free cash flow.

• Productivity of stores do not reach target as they mature.

o Mitigants: SPSF of DXL has grown from $147 in 2012 to $180 in 2016, and

management guides $185 this year

o Number of stores with SPSF greater than $200:

2016: 49; 2015: 40; 2014: 27

• Growth initiatives slow down and the Company can't reach target number of stores

o Mitigants: I would gladly take their free cash flow.

In summary, I believe DXLG is a better-than-average retailer that is coming out of years of

capital investments and will soon demonstrate its strong cash flow generation which also

alleviate concerns on leverage. The high FCF yield and the strong internal growth

prospects (maturing fleet of stores) make this an attractive investment.

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

Catalyst

FCF generation and debt paydown

show sort by

			2017	2018
Price:	2.35	EPS	0	0
Shares Out. (in M):	49	P/E	0	0
Market Cap (in $M):	116	P/FCF	0	0
Net Debt (in $M):	71	EBIT	0	0
TEV (in $M):	187	TEV/EBIT	0	0