Description

Situation overview

Superior Group of Companies, Inc. (“SGC”), the self-proclaimed “100 year-old-startup” is a collection of businesses with attractive growth opportunities, significant customer credibility following strong execution and customer service during the pandemic, and a proactive, engaged, and competent management team with an “iterate until you figure it out” mentality.  The company has worked over the last several years to diversify away from its legacy institutional medical scrub business (as recently as Q118 the company still filed as “Superior Uniform Group”) into more attractive products and markets that still play to SGC’s expertise and strengths.

At ~9x trailing EBIT, this isn’t a dirt cheap cigar butt, but it is undervalued relative to its growth and profitability outlook and as such, simply meeting the low end of its guidance over the next 4.5 years will deliver an 18% IRR to investors (doubling of the stock plus dividends).  I think there’s a good chance that operating performance and stock returns will be much greater than this.

The lazy part of me says that this return is available because investors aren’t looking past the weakness of the legacy scrub business, but the reality is that the company has been hard at work (and learning) integrating multiple acquisitions and consolidating back office and operations over the last few years, so the operation had not been firing on all cylinders prior to the pandemic.  It is reasonable for an investor who isn’t looking too closely to conclude that recent performance improvements will be non-recurring, and miss the fruits of the products, channels, and markets, that SGC is expanding into.

Company overview

Superior Group of Companies, Inc. (“SGC”) was founded in 1920 (by the current CEO’s great-grandmother) and has three main businesses: uniforms, remote staffing solutions (“TOG” or “The Office Gurus”), and promotional goods (“BAMKO”).  The company is based in Seminole, FL with facilities in Texas, Arkansas, Mississippi, California, Louisiana, Haiti, Jamaica, El Salvador, and Belize.  SGC had 4,600 employees as of year-end (800 U.S. and 3,800 international).  No customer accounts for more than 10% of sales (the company has a slide in its investor deck showing all kinds of blue chip customers such as AT&T, Wal-mart, UPS, Coca-Cola, etc.).  The company’s supply chain network includes 35 locations across 12 countries.  SGC believes this breadth gives it a leg up when sourcing is difficult.  As discussed below in “Key Risks,” 35% of the company’s stock is held by management, directors, and their family members.

Total TTM revenue was $545mm with a gross margin of ~36% and ~$54mm of operating profit (~10% margin).  SGC is guiding to $525mm of revenue for CY2021 as some of the PPE and other pandemic revenue that it has generated over the last few quarters rolls off.  At the current share price of $21.98 with 16.1mm diluted shares, market cap is $354mm (TTM P/E of 9.4).  Balance sheet cash of $7.5mm, total debt of $114mm, SERP liability of $14mm and contingent liabilities of $3.5mm result in an EV of $478mm (TTM EV / EBIT of 8.9).

This is not a complicated story or thesis.  I’m basically just saying that SGC will meet the low end of its multi-year (4 years ending 2025) guidance and in doing so will deliver an attractive return to shareholders.  There are enough moving parts however that I’ll go through the overview and guidance together for each segment in order to present it as coherently as possible.

Segment 1 of 3 - Uniforms business

The uniforms segment is the company’s original business and represents ~50% of SGC’s sales (~$290mm) and ~25% of operating profit (~$14mm or ~5% of revenue) on a TTM basis.  As recently as 2016, uniforms represented over 80% of revenue and over 85% percent of operating profit, which gives an indication of how quickly and profitably the other two segments are growing.  On a TTM basis, approximately 20% (8.5% in most recent quarter) of segment revenue represents PPE sales that is likely to roll off in the coming quarters.  This roll-off is baked into the company’s guidance and my valuation cases.

This segment consists of three subgroups:

--Institutional medical apparel - this is the original business that, until the last decade or so, generated nearly all of its revenue.  SGC contracts to sell medical scrubs (mostly under its Fashion Seal brand) to service institutions (laundry services) such as Cintas, Unifirst, and Aramark, who in turn offer these products to customers such as hospital systems on a continuous, laundered basis.  It is no longer a great business.  It is mature, highly concentrated, and competitive.  The laundry services in many cases offer their own competing products alongside those of SGC.  While customers are theoretically sticky due to the logistical headaches of swapping in a new supplier, pricing power appears to be weak and at ~$70 million of revenue, SGC already owns about a third of the ~$200mm U.S. market.  Over multi-year periods this appears to be a GDP/LSD-growth market, though I estimate that this business was flat to slightly declining leading up to 2020.  Management clearly saw over a decade ago that this business alone wouldn’t be able to support continued growth and success for the consolidated company and began developing and acquiring adjacent businesses (described below) that it believed built off the strengths that SGC had developed in operating Fashion Seal.

While I expect the core Fashion Seal operations to deliver minimal revenue and margin growth during the projection period (basically flat operating profit), SGC has developed the “Indy” line of scrubs, which is a “fashion scrub” (more attractive cuts, more technical fabrics) that can survive the torments of the industrial laundry system, which at the moment is a differentiated product.  SGC has stated that the response has been tremendous, its initial supply was sold before it was available, and it expects this product to exceed “high seven figures” in sales within a couple of years.

--The second business line within the uniforms segment is the employee I.D. business - named HPI - basically non-healthcare uniforms (Taco Bell, Lowe’s, airlines, hotels, amusement parks, manufacturing).  While I wouldn’t call this a high-growth exciting business (the company’s multi-year growth projections for this segment have historically been around MSD), the dynamics are somewhat better than the institutional healthcare apparel segment because the market is much bigger (in rough numbers $2.5 to $3+ billion) so at ~$160mm of revenue (a little over half of segment revenue), HPI only has around 5-6% market share.  While I could be far underestimating HPI’s potential, I assume they’ll continue to grow around the MSD CAGR (though somewhat lumpy as larger contracts may come on / off).  In terms of specific drivers, the company has noted that it has received positive feedback from many new and existing customers who were let down by competitors with weaker supply chains or who just failed to deliver during the pandemic.  In many cases, HPI was able to sell these customers needed PPE and then retain them as a customer for sales of other products.  I thus expect HPI to be able to take share going forward.  A second driver of taking share is that HPI has the ability to hire salespeople away from weaker competitors (who will bring their customer relationships with them) or just outright acquire these companies.  Finally, and perhaps most importantly, SGC will be opening up HPI’s product line to be sold by sales reps in SGC’s promotional products division.  This means that where HPI formerly had 5 sales reps selling their products, there will now be 75 reps (the company notes that uniforms and promotional products are often handled by the same buyer groups within customers).

--CID - “retail healthcare apparel” - Retail is a bit misleading in this context because SGC is still selling its products on a wholesale basis, however it is selling into retail channels, for healthcare practitioners to purchase on their own.  This is the best of the three businesses within the uniform segment.  SGC acquired CID in mid-2018 (after CID grew from nothing to $60 million of revenue in seven years) as part of its efforts to diversify away from Fashion Seal into businesses where SGC’s capabilities would be valuable.  With ~$65 million of revenue in the $800 million U.S. retail scrub market (~8% market share), CID has plenty of room to grow and, compared to the institutional business, is marked by shorter sales cycles and many more “at-bats” given the tremendously more fragmented customer base.

You may be familiar with the recent IPO of FIGS, which is also attacking the retail fashion scrub business.  I think there is likely room for both of these players as FIGS scrubs tend to be about 2x the price of CID’s fashion scrubs (though they do appear to be a nicer product and are definitely better marketed.  I think of this as Nike Womens not disappearing when Lululemon grew to $1 billion from nothing), and FIGS sells a large amount of non-scrub fashion such as vests, jackets, and athleticwear.  In its S-1, FIGS refers to its addressable as a $12 billion domestic “healthcare apparel” market and its $67 billion international counterpart.

This is also the area in which SGC has the most uniform growth initiatives in place.  The company has been working on its marketing and distribution strategy in Europe and now has a warehouse up and running and is looking forward to greatly expanding that business in Europe, Australia, and the Middle East (prior to the CID acquisition it didn’t have a great platform from which to do this).  SGC currently has about $30mm of international revenue across all of its businesses and is looking to expand that to $100 million in the next couple of years.  I project $70 million of international CID revenue, though that could end up being low.  Other growth drivers include the new “Indy” fashion scrub line, a (potentially) permanently higher level of PPE for places like dentist offices and, most importantly, an explosion in ecommerce business, which SGC is now also focusing on.  In particular SGC has highlighted its recent partnership with distributor Sanmar, which has a significant ecommerce presence, and distributes to 20,000 other promotional products companies (yes, confusingly, these would be competitors to SGC’s own promotional segment, but why not have these competitors carry CID apparel?).  The CEO estimated on a recent call that 100,000 salespeople from different companies across the U.S. carry the SanMar catalog with them when they call on their customers.

So in terms of these three sub-segments coming together to meet SGC’s segment guidance of at least 12% revenue growth, I think of it as “if Fashion seal is flattish (or CPI-ish if costs are increasing so still flat operating profit), and HPI is growing at ~5%, can CID grow quickly enough to make up the difference?  I believe the answer is yes.  In simple terms, this requires adding $154mm to the uniform segment’s 2021E ~$269mm of revenue.  If Fashion Seal sells $8mm of Indy products, HPI adds $34mm by growing at 5% and CID earns $70 million in international revenue, that leaves $42mm of revenue for CID’s domestic business business to earn, which is a 14% CAGR and would be an increase in market share from 8% to 10% (with CID’s domestic market growing at 6%).  This seems particularly reasonable to me given the significant new distribution opportunities on the horizon.

I’ll close by noting that multi-year revenue guidance for this segment was previously 5-8% but the company increased it to 12% in Q320 as a result of what they thought were structural improvements that they were seeing in the business (particularly on the healthcare apparel side) so their confidence level is clearly high.

Segment 2 of 3 - Promotional goods business (“BAMKO”)

The promotional goods business spans retail merchandise (your Green Bay Packers-branded desk lamp), promotional merchandise (a branded “welcome” pack containing supplies for a newly-joining gig worker), packaging and branding (creating distinctive packaging for companies like Birchbox), and a variety of related consulting activities (market research, industrial design, sourcing, quality control, logistics, ecommerce).  While BAMKO’s website (not surprisingly) touts its value-add consulting services, the company’s 10k states that revenue for this segment is primarily generated from the sale of finished products to customers and the segment’s low-30s gross margins also imply a product-heavy revenue mix.

This business represents ~40% of SGC’s TTM revenue and ~50% of the company’s operating profit.  BAMKO generated mid-single digit EBIT margins and EBIT / Assets until the pandemic hit, at which point business exploded and EBIT margins rose to the mid-teens and EBIT / Assets got to the mid-20s and higher.  Excluding the impact of PPE sales, BAMKO’s core business grew ~11% in 2020 (after 33% growth in 2019) while industry promotional spending was down 30%.  The company attributed this outperformance to its on-the-ground sourcing team in Asia as well as exposure to a diverse set of verticals that outperformed the broader industry such as home gifting, customer retention programs, gig economy, customer acquisition programs, and virtual conference gifts.  BAMKO also found ways to source and sell PPE in 2020, resulting in an overall growth rate for the segment of 88% in 2020.  The company also noted that its reliability in sourcing quality PPE turned many PPE customers into core promotional product customers.

The promotional products industry has favorable characteristics - approximately $20 billion in size (implying a 1% market share for BAMKO) and highly fragmented with 23,000 participants.  BAMKO is the 11th largest player according to ASI research, where the top 6 represent $3.4 billion (~17% market share) and the top 40 represent ~$7 billion (~35% market share).  SGC believes that BAMKO will be able to grow significantly by (a) taking share from smaller weaker players, (b) hiring skilled sales professionals from competitors, who will bring customer relationships with them, and (c) acquiring competitors where it makes sense.

The company’s 12% 4-year growth target represents a deceleration from 2020 (even excluding PPE) and from the most recent quarters.  BAMKO appears to have executed well and taken share in both upmarkets and downmarkets.  As stated elsewhere, this guidance represents the minimum expectation of management.

Segment 3 of 3 - Remote staffing solutions business - TOG

TOG is the “Amazon Web Services” of SGC.  It is high margin, capital efficient, and growing like a weed.  This segment grew out of SGC’s own internal back office operation.  In 2009, because the operation seemed to be very effective in providing excellent, low-cost services to the uniforms division, SGC began selling TOG’s services to external customers.  Today, TOG operates out of El Salvador, Belize, Jamaica, and the U.S. and provides order entry, cash collections, vendor payables processing, customer service, sales, and other services.

On a TTM basis, TOG represents ~10% of revenue and ~25% of operating profit.  Segment operating margins have been steady in the mid-20s with gross margins exceeding 50% and the business has generated EBIT / Assets of over 40% in each of the last three quarters.  While management has gotten some pushback on this business due to it not being their “core competency,” I would argue that this business is executing amazingly well and provides a virtuous cycle of improving internal operations while offering an excellent product to external customers.  The success of the product shows in its results - this segment has grown organically from ~$9.6mm in 2016 to ~31mm TTM revenue - a CAGR of nearly 30%.  Revenue growth for the most recent four quarters was Q320 25%, Q420 27%, Q121 42%, and Q221 67%.  Aside from strong execution from the head of this business, the company has stated that the growth is driven both by growing existing customers and adding new customers, and that once many customers realized during the pandemic that certain functions could be performed remotely, they were interested in outsourcing these to a low-cost provider like TOG.

The company has said that customer contracts of 5-25 seats are their sweet spot.  This division has no salesforce and has achieved its growth through word of mouth.  SGC has also said that this division has continually outperformed internal expectations and that its growth bottleneck is SGC’s own ability to add capacity (team members, office space when necessary) rather than customer demand.

Four-year revenue growth guidance for this business is 18%, which leaves a lot of room for this segment to decelerate and still have a healthy margin to beat guidance.

A point on margin guidance

The fourth leg of SGC’s multi-year guidance is that consolidated operating margin will exceed 10%.  This may seem particularly un-ambitious (or perhaps just conservative) given that they are currently generating that level of margin and are expecting a 12.5% consolidated revenue CAGR but the company notes that some of the extra pandemic business in 2020 drove extra margin (I’ve tried in the discussion above to set aside even non-PPE 2020 performance, or at least point it out as potentially non-recurring) so they view this as improving from a normalized current 8% operating margin to 10% in 2025.

If the company’s initiatives were mostly about blocking and tackling in the institutional scrub business, I’d be potentially concerned about the margin guidance, but SGC is continuing to focus its efforts on higher margin (both gross margin and opex margin) opportunities.  I think this margin guidance is an easy win unless I end up being wrong about SGC meeting its revenue guidance.

One more general comment

I’ll offer one last thought on why I think SGC will have an easy time making at least the low end of its guidance: reading through the transcripts and speaking with management, one gets the impression that this is a process-focused company.  It would be easy for Michael Benstock to continue to throw resources at a low quality scrub business to try to squeeze some extra blood out of a stone, but instead they’ve been thoughtful about expanding their product line to meet the demands of the current market, finding ways to increase distribution, and acquiring operations that are truly complementary to their expertise and assets.

They continue to try things.  Sometimes they don’t work out, as when they tried selling institutional scrubs directly to healthcare systems, but often they do, as when they convinced the government of El Salvador to allow employees to work from home so that TOG could continue operating during the pandemic.  The company sourced and sold ~$170mm of PPE during 2020 and 2021 despite generating total revenue of $377mm in 2019.  Management reduced executive salaries, cut the dividend, and negotiated a temporary stay with its banks in order to conserve cash in the depths of 2020.  I have confidence that by continuing to try all types of things in a disciplined manner, they will find the best opportunities for profitable revenue growth.  They sometimes refer to themselves as the “100-year-old” startup in speaking to this mentality.

Valuation

Base case

My base case valuation assumes that the company hits its minimum guidance of $525mm of 2021 revenue followed by a 12.5% CAGR (~12% in Uniforms and BAMKO, ~18% at TOG) from 2021 through 2025 and operating margin of 10%, reaching EBIT of just ~$86mm in 2025.  SGC maintains its 8.9x trailing EBIT multiple for an EV of $762mm and generates a cumulative ~$65mm of cash after paying dividends (I’m using the high end of their capex guidance of 1-1.5% of revenue, as well as their current working capital ratios, though the company states that working capital is about $25 million higher than it needs to be right now).  Backing out ~$124mm of existing net debt and liabilities (SERP liability plus acquisition-related contingent liabilities) results in a share price of $43.59 or roughly double the current share price.  In combination with the current $0.12 quarterly dividend, this generates an ~18% IRR to investors over the 4.5-year period.

Downside case

There is no hard asset value-type downside protection.  Rather, soft downside protection is provided by SGC’s long-standing customer relationships and credibility as well as the competence and proactiveness of the management team.  

That said, it’s difficult to imagine SGC trading below 6x EBIT even if they fall short of their guidance (absent some kind of unforeseen disaster).  I’m using a downside case of 3% revenue growth and 8% operating margin with a 6x EV/EBIT multiple.  The 30% cut in multiple hurts obviously.  At the end of 2022 the downside return is about -55%.  However the company is still generating about $20mm of cash per year and stockholders are still collecting $0.48 in dividends each year so if the company still hasn’t worked out its issues by 2025, total value received is $15.85 or ~28% lower than the current purchase price.

Conclusion and upside

So is this just a “double your money or lose 50%” opportunity?  Hardly.  The probability of outcomes is heavily skewed towards the positive - I think the base case is a reasonable (i.e. high likelihood) one, while the downside case is fairly punishing (i.e. low likelihood).  In addition to the favorable probability weightings, there are a number of factors that could mean a high likelihood outcome exceeding my base case.  A few of these include:

--Capex coming in lower than the 1.5% of revenue (top of the company’s range) that I’ve used (the company has stated that this is likely if revenue targets are met).

--Normalizing working capital to the correct current level and crediting TOG for its lower WC requirements vs Uniform and BAMKO segments.  Additional cumulative cash of ~$36mm or ~$2.25 / share.

--Management has emphasized that the 10% operating margin projection is a minimum

--Additional accretive acquisitions.  The company is looking to add $100mm (revenue) or more in bottom-line-accretive acquisitions.

--Fashion Seal business actually performs instead of being flat

--HPI business takes share instead of growing with the industry

--TOG and BAMKO continue operating closer to their current trajectories

--Continued growth and compounding beyond 2025

--Another spike in demand for PPE and medical uniforms (please no)

Key risks

--Supply chain - this is the big one.  While the company demonstrated during the pandemic that its strategy of having a broad and diverse sourcing network and having permanent teams on the ground in each location gives it a significant leg up in sourcing quality materials when supply is constrained, the fact remains that most of the world’s fabric comes from China and a few other places.  If there were an inability to source raw materials from China (for political or other reasons), this would make a significant dent in SGC’s ability to manufacture and sell product.  The company has noted its ability to put through price increases when necessary in situations like the present when freight costs are elevated.

--Domestic labor supply - the company noted on its most recent conference call that it was facing some challenges in hiring workers.  SGC believes that “the coming cessation of the supplemental unemployment benefits combined with our creative and aggressive recruitment, incentive and retention programs, should allow us to maintain needed staffing levels”.  Again, an ability to pass through cost increases provides some mitigation to this risk.

--Cash flow vs management incentives.  While I believe that management’s heart is in the right place, the board has attempted to align interests by incentivizing management on EPS.  Especially in a company like this where some segments are working-capital intensive (mostly the uniform segment), I’d prefer that the management team be incentivized on cash flow.

--Family control - the founding Benstock family, including CEO Michael Benstock, owns over 20% of the stock, and “our executive officers and directors, and certain of their family members” collectively own 35% of the stock.  For better or worse minority investors are along for the ride on the Benstock family train.  I think this is for the better.  In the past fifteen years the number of family members employed at the company has greatly decreased (eliminating the family-related conflicts that family companies can have) and the company has worked towards an independent board.  Michael Benstock seems to take pride in making the company excellent, rather than being lazy and disengaged or treating it like a piggy bank.  He has said his family’s net worth is almost completely tied up in the company.  As discussed above, this management team has shown themself to be engaged, creative, and proactive.

Catalyst

--Mostly quarterly earnings showing progress on numerous company initiatives

--Growth of new Indy scrubs line

--HPI taking share based on credibility during the pandemic, hiring competing salesforce, and having 75 internal sales reps instead of five

--Launch and expansion of international CID business as well as expansion of distribution channels for CID (omnichannel efforts especially ecommerce, SanMar partnership)

--BAMKO and TOG keep growing quickly

--Margin and overall operational improvements from the warehouse / ERP / backoffice consolidation that the company has worked on over the last few years

--Potential boom in uniforms and promotional spending if/as economy completely opens up

--More pandemic (again please no)