Description

Delta Apparel is likely a 2-7 bagger in the next few years. The company has $312 million of inventory and receivables against $112 million of current liabilities and about $159 million of debt for a total tangible liability of $271 million. The company also owns about $40-50 million of real estate and an industrial park in South America that is worth another $20 million. These tangible assets bring shareholder value to roughly $101-111 million. Like many apparel companies, Delta suffered from the Covid bullwhip effect. The company stated it will pay off $50 million of debt in 2023 by normalizing inventory. Adjusting for the excess inventory, the enterprise value is only $180 million.

The debt matures in 2027 and has light covenants with a fixed coverage ratio of 1.0 times. The lender is charging a low-interest secured overnight financing rate (SOFR) plus one percent. The debt is backed by the inventories and accounts receivable, which can be liquidated quickly. This is different from lending against operating cash flow, whereby the lenders often require a fixed-charge coverage ratio of 3.0-7.0 times. In plain English, the lender does not view Delta Apparel as a risky venture. The lender also recently waived the fixed charge coverage ratio. 

Delta Apparel has two reportable segments and three distinct businesses. The company owns Salt Life, a cultish brand popular in the Southeast U.S. It appeals to outdoorsy people who love to fish, hunt, and spend time in the ocean and at the beach. Customers put Salt Life decals on their pickup trucks and the brand has an outsized social media presence. Salt Life generated $8.2 million of operating income on $60 million of sales in 2022 and sports a nice 13.7% operating margin while growing stores rapidly. We believe the brand can get significantly larger and can potentially reach a half a billion dollars in sales, like Tommy Bahama. Given the growth opportunity, operating margins, and strong brand, we believe that a 15-20 times operating-income multiple is reasonable for a private equity buyer. This would value Salt Life at $120-$160 million.

Within the Delta Group segment, there is a commoditized active wear business and a more specialized digital printing business called DTG2GO. We estimate that the commoditized business generates about 6-7% operating income on $320 million of revenue in a normal year. Applying a 5 times multiple, we value this segment at $96 to $112 million. On the other hand, DTG2GO offers digital printing for companies such as Fanatics and Redbubble, which allows customized design for a single piece of clothing. Fanatics, a $30 billion private company, shut down in-house printing and fulfillment functions and outsourced them to DTG2GO. We have spoken with industry people, management, and other shareholders. We believe the company has a combination of digital printing knowhow, scale, and existing infrastructure that makes DTG2GO competitive. There is also a barrier to entry since the cheapest machines start at a quarter million dollars and a local custom T-shirt shop cannot just start competing. DTG2GO is currently generating roughly $60 million of revenue with a mid-teens operating margin. In the recent quarter, DTG2GO grew around 20%. DTG2GO is worth another $120-160 million as well. Adding everything up, we get to a 167-310% upside today.

1. Salt Life - $120-160 million
2. DTG2GO - $120-160 million  
3. Delta Activewear - $110-120 million  
4. Real Estate and Green Valley Industrial Park - $60-70 million  
5. Excess inventory - $50 million  
6. Corporate expenses - ($116 million) which assumes $14.5 million capitalized at 8 times
7. Less $157 million of debt

Net to shareholders: $187-$287 million of private market value

Fiscal 2023 will be a tough year as the company works through high-cost inventory. By 2024, we believe that Delta Apparel can earn $25 million of net income, which would be 2.8-3.5 times earnings. Further, the earnings will accumulate on the balance sheet and the company has a history of buying back shares around mid teens. If one were to hold the stock for three years, the accumulated earnings could generate an additional 100% return. In the short term, very few shareholders want to own this business, because quarterly earnings will likely be subpar. Looking out three to five years, if Salt Life and DTG2GO can continue to grow at 15% a year, the net income could potentially grow to $30-$40 million a year. By then, the better businesses of Salt Life and DTG2GO will be a bigger portion of the earnings power. The company may trade at a 10-12 times price-earnings multiple, which could value the company at $300-480 representing 328% to 585% upside. 

We have analyzed management’s historical capital-allocation track record. The CEO has transitioned the business away from brandless and commoditized businesses into higher-growth and branded businesses such as Salt Life. We estimate that the return on equity on the Salt Life acquisition is almost 10 times today, on $15 million of cash equity and two promissory notes in 2013. Salt Life still has tremendous runway to continue to grow in the coming decade. The DTG2GO acquisition is also impressive. Based on the 2022 operating results, Delta bought DTG2GO at about 4 times operating income after growing the business for five years. Acquisitions prior to 2013 have not yielded the same attractive results. Hence, it is impressive that the CEO made a conscious decision to high grade the business over time. The CEO is 65 years old and has expressed a desire to retire in the next five years. We believe that Delta Apparel will likely be acquired in the coming years.

Delta Apparel does have flaws, like many value investments. We believe that the company disclosure could be improved. There seems to be difficulty in ramping up growth, especially in the DTG2GO segment. The chief financial officer recently resigned due to subpar performance. But we think the stock price has already reflected all these issues. Unlike most companies trading at liquidation value, Delta buys back shares, generates profit, and has two fast-growing quality businesses. 

Variant Viewpoints versus previous write ups 

DTG2GO is not as a good of a business as a previous write up. But I think the scale, know how, and the network of warehouses make it differentiated than some small mom & pop start up.  The ability to fulfill large orders for large customer is also a strength. But it earns a decent return on capital and is growing fast. Fanatics ($30 bn private valuation company) tried to do the custom printing in house and decided to shut down and outsource to DTG2GO. In addition, there are technical issues with ramping up production in DTG2GO. There has been stop and go in DTG2GO. We believe that this likely means that custom printing hundreds of apparel pieces per hour is not an easy task and new competitors likely have a tough time ramping up production. 

Management team is okay, but not terrible. There are a few shareholders who are upset at the moment. He is not a great communicator. But the capital allocation has significantly improved in the past decade. 

Share buyback is on the back burner for now. The asset based loan needs to be paid down. If one reads the language in the asset based loan, it is clear that the lender cares about the amount of inventory and reveivables way more than EBITDA.  

Catalyst

Getting through fiscal 2023, allowing higher cost cotton prices to work through the system, working down excess inventory and paying down asset back loan by $50mm 

Further growth in Salt Life and DTG2GO