Description

Thesis Brief:

I'm going to include a team member's more traditionally and dryly prepared bullet-point write-up below, but to just package the punchline more neatly, and maybe save some ammo for the message boards if folks wanna throw stones:

Our thesis case is that DXLG generates just under $1 in FCF p/ share this year; the stock is at $1.20. We'll paint our base or conservative case of $.85 of FCF p/ share below, but either way, there aren't a ton of palpable, possible 10-baggers left out there, so anybody with a reasonable illiquidity tolerance is gonna have to take a shot here. Over the last couple months, top line trends have inflected dramatically, or so say an amalgamation of direct store checks spanning over a dozen states, primary research in collaboration with two former C-suite executives and the former head of real estate, and high-correlated alternative data. But the flow through is going to be even better, aided by recently abated rent structures in physical stores, web scraping based indications of a materially less promotional environment, and structural SG&A cuts. As another reference point relative to our FCF p/ share estimates, management recently guided to mid-teens millions of EBITDA for this fiscal year. It's hard for us to see them doing less than 60; the enterprise value is 130.

Like with the move in KIRK from a dollar to 20, or CTRN from 7 to 70, if we're right, pundits will conjure up all sorts of expressions for why this is a 25 dollar stock when it's at 10-12. To be sure, they'll be reasonable academic arguments posed mostly to backfill an explanation for what has already occurred, almost as an ode to market reflexivity and the notion that people want to put a messy world into intelligible order. To us, it's more about the initial post-inflection price discovery that takes place when it becomes clear that this company might be able to buy down it's entire equity value with the cash it generates in little more than one year. We're seeing once-in-a-century shifts in consumer behavior, and these shifts have tails to them, especially when a given business is dramatically better positioned structurally and the entire big and tall world just got bigger and taller (or at least bigger), all while the many occasions they didn't dress up for in 2020 will come back and then some this year and next, and a heck of a lot of the country has a wad of cash burning a hole in its pocket. Yet even beyond the reopening renaissance period, this is a niche business with characteristics that should lead investors to capitalize the earnings power we expect it will imminently reveal. We think the path to $7-8 bucks p/ share, 5x plus, is within reach by this fall. 

Business Description / Background

Destination XL (DXLG) is the largest specialty retailer of big & tall men’s clothing and shoes. The company operates 311 stores under the Destination XL and Casual Male XL banners.

Overview

3 straightforward points

-        DXLG is an underappreciated reopening beneficiary

-        Company-specific initiatives will drive material uplift to top line growth and long-term profitability

-        Current valuation reflects material disconnect from the company’s underlying fundamentals

-        Our work suggests business trends have accelerated meaningfully into 1Q, with sales in-line or above 1Q19 levels. This, in tandem with the three aforementioned points, gets us to FY2021 revenue of $480mm (vs. guidance of $385-$402mm). Layering on +400 bps of merchandise margin expansion (due to reduced promotionality) and the associated occupancy leverage drives our FY21 gross margin +150 bps above FY19 levels. Finally, after adjusting the company’s cost base for the structural cost take-out they have achieved, we arrive at the company generating $45mm of FCF ($0.85/share). Assuming an 8-10x FCF multiple implies a target price between $7-$8.50 (+467% to +580% upside).

Underappreciated long-term Covid beneficiary

-          Uniquely positioned - DXLG’s is uniquely positioned and will benefit disproportionately relative to its retail peers

-          The company operates as the largest player in a niche market (big & tall) with favorable competitive dynamics relative to other retailers

-          Greater need for in-person fitting creates natural friction to e-commerce competition

-          “[the] customer wants to come in and see how things fit, not the typical shopper” – former Director of CRM

-          A “captive” customer base given limited alternatives within an already underserved segment of the market

-          Advantageous store footprint – positioned almost exclusively off-mall, allowing for a faster rebound once restrictions are loosened / overall consumer mobility increases

-          Pent up demand - demand from existing customer base to be magnified as customers need to replenish/replace their wardrobe due to weight fluctuations

-          Expanded core customer demographic - Anticipate step-function increase in the company’s core customer demographic / overall sales base post-Covid

-           COVID has driven an increase in obesity which has been well documented in numerous studies (JAMA – Journal of the American Medical Association, the American Heart Association, and the Mayo Clinic have all published on the subject)

-          For example, one study published in JAMA suggests the average American gained 7.08 lb.

-          Unlike other retailers, DXLG benefits from a “captive” customer due to limited alternatives, enabling them to capture a significant portion of any incremental demand

Meaningful top-line growth and operating leverage as sales rebound

●        The Company is executing on multiple company-specific initiatives to improve long-term profitability as sales come back faster than the market appreciates

○        Aggressive top-line rebound

■        Highly predictive credit card panels (96.6% correlation) are indicating +30% growth Y/Y in 1Q (QTD), which when making certain assumptions when extrapolating the trend, should correspond to growth of +69% Y/Y in 1Q (or roughly 86% of 2019 sales)

■        Dozens of channel checks across multiple geographies at the store level suggest accelerating sales from 4Q to 1Q, reaching sales volumes in-line or above 1Q19 levels – (“have been crushing 2019 comps since the 2^nd week of March and there is no sign of it letting up” – store check)

●        “everyone is similar, getting to even or up” – store check (in reference to 1Q trends vs. 2019)

●        “everyday [we] are consistently beating goals” – store check

■        Other independent channel checks/primary research (incl. working with the company’s former Chief Digital Officer) implies systemwide sales significantly ahead of plan and e-commerce sales of 30%+ Y/Y

○         Long-term margin expansion

■        The company reduced operating expenses by $52mm as part of its effort to rationalize its cost structure throughout FY2020

●        We estimate approximately 50% of the cost take-out is structural and will not return as top line recovers, driving meaningfully improved incremental margins

■        Consistent with the retail space broadly, and per our day-by-day analysis of historical promotions, the company has substantially dialed back its promotionality vs. both 2020 and 2019 levels, which will lead to substantial merchandise margin expansion sequentially

■        The Company has eliminated 29% of its corporate headcount

Current valuation ascribes minimal value to the business

●        We see a reasonable path to DXLG generating $0.85/share of FCF (approx. 65% of current market cap)

●        The company operates under two segments: 1) In-Store and 2) Direct

○        In-Store revenue declined 49% in FY2020, while Direct grew +15%

○        DXLG provided FY2021 revenue guide of $385-$402mm (-15% to -19% Y/Y)

○        On a per store basis, DXLG ended 2020 with In-Store sales at approx. 63% of 2019 levels

○        Our work (As per above) suggests sales have accelerated in 1Q to approx. 80%, with recent weeks trending in-line with 2019 levels

○        As we continue to reopen, we expect sales to trend modestly above 2019 levels (due to reasons outlined above), resulting in FY2021 In-Store sales per store reaching 99% of 2019 levels

○        Layering in a modest +11% Y/Y growth for Direct (within guidance), equates to revenue of $480mm (vs. guidance of $385-$402mm)

○        This corresponds to $45mm of FCF

○        Assuming an 8-10x FCF multiple equates to equity value per share between $7-$8.50 (+467% to +580% upside)

Risks

-          COVID

-          Restrictions stay in place longer than expected

-          Permanent shift in consumer behavior - company loses customers to e-comm channel

Google Trends for “big & tall”

Catalyst

Catalyst

-          Covid-driven obesity driving long-term demand for extra-large clothing

-          Reopening beneficiary

-          Permanent cost cuts and reduced promotionality leading to sustainable margin growth