Delta Apparel (DLA): Far Below A Growing Book Value, Positive Read Through From Nike

Delta Apparel (NYSE:DLA) has been an incredibly disappointing stock so far. They have mostly executed on their growth opportunities, yet the stock has fallen significantly and they are far under 10x forward earnings, despite having two $50-$100m growth businesses that will grow earnings over 10 %, and a $300m+ activewear business that should be either flat or growing.

A significant portion of the fall may be from correlation with Hanesbrands (HBI), which is not a fair comparison as Hanes is mostly focused on the basic apparel business, while Delta is also a decorator and distributor. Hanes is also focused internationally while Delta is focused on North America, another factor in Delta’s favor.

Management activity supports the bull case as the company has in the last few months hired more executives than at any time in its history and had significant insider buying.

Apparel pricing trends are bullish for the upcoming quarters as the most recent quarter had extraordinarily weak pricing activity, but pricing has rebounded per Adobe Analytics as current pricing across apparel is >10 % above its lows this summer. For the overall holiday season Mastercard report apparel sales up 4.4 %. This is down in inflation adjusted terms but is not a disaster.

Delta’s largest customer, Fanatics, just raised additional financing at $31 Billion, >10% above its most recent round in the Spring.

Near Shoring

Finally, the UFLPA may cause significant migration of the apparel supply chain into Central America, where DLA’s manufacturing facilities are. Mexico’s GDP per capita is almost as high as China, which is approaching too wealthy to produce apparel, so DLA’s facilities in El Salvador and Honduras should be prime targets to realize increased demand from the UFLPA and changing global supply chains. In addition to this causing increased revenue, this may also be incrementally positive for margins in the apparel industry for those that produce in North/Central America.

This is already happening as the November export data released from China indicated, with exports down 25 % to the US y/y, below October, and further declines expected. A review of trade.gov data shows that as of October, cotton product exports from China are down 30-50% in many categories and look like they will fall further, especially given the November export data. While China is less of a presence in the cotton category, the amount of the reduction is still significant compared to the total imports from Honduras and CAFTA-DR, meaning there is definitely room for at least a 10-20 % increase to this region. Moreover, ASEAN as a whole is down in some categories as well as the region depends to some extent in China for raw materials. A review of Los Angeles and Long Beach container data can also add context.

Reviewing the export data from Honduras, the trend is essentially flat, however this is likely due to the inventory glut, and may show a significant increase once the inventory glut is over and supply from elsewhere has declined even more. It remains to be seen what part of this is noise, but thus far it looks at least partly structural, especially considering the difference between US export data and EU export data.

Most concretely, on the recent conference call management very clearly stated that they expect the Activewear business to be flat for the first half of FY 2023 and grow in the second half, and they are usually conservative with their revenue estimates. When you consider that DTG2Go and Salt Life will both be growing double digits, and likely over 15 %, the outlook for next year should be something like 5 % revenue growth overall or better, with the higher margin businesses comprising a growing share of overall revenue. There could be a significant acceleration from the trade dynamics once the inventory glut clears in the next few months as well, and it seems possible/likely that the trade dynamics could be very positive for pricing and margins.

Finally, at this price Delta Apparel is far below its tangible book value. It is very possible that there should be a discount applied to the DTG machines, but it is also likely that their real estate is worth significantly more than the value it is assigned on the balance sheet.

Risks

The biggest risk to Delta Apparel is that they are likely to suffer further market share erosion in their basic apparel business. This is their lowest margin business by far, and comprises a small portion of their overall income, but is their largest revenue business, with the global brands business coming in second. However the global brands business will likely surpass the basic apparel business sometime in the next year or two. Thus far they have been able to grow their other business lines fast enough to more than compensate for erosion in their basic apparel business.

For the time being near shoring driven demand for manufacturing in this hemisphere should also boost the basic apparel business as well, so there is likely not immediate concern in this area.

Liquidity and Leverage

Delta finances most of its inventory with debt, which leads to the appearance of significant debt on the balance sheet. This can scare off some investors. It is important to understand that this debt is backed by highly liquid, in demand inventory which is being rapidly sold. Unlike a fashion oriented brand like Lululemon (LULU) Delta’s >75 % of inventory is “evergreen”, and not at risk of obsolescence due to consumer tastes with the exception of the inventory they hold for Salt Life, which is a small portion of their overall inventory. Delta is not in need of funding, and rather than dilute has steadily reduced share count over its history. If Delta ever needs to raise cash very fast, all they have to do is reduce apparel production and sell their existing inventory into the market and that will allow them to reduce the asset backed debt rapidly.

Rising interest rates will be a headwind in 2023, but this effect should be a very short term $1 per share in earnings or less, and not be large enough to warrant a huge change in the valuation of the company, especially because interest rates will likely start to come back down at some point in the next year as well so it will be a short term effect.

Present Outlook

In the immediate term, it is very likely that Delta will have its best ever quarter in DTG2Go because the management commentary from the conference call allows a detailed read through of the revenue they will realize from the Polaris machines they purchased. In the conference call they stated they would be running two shifts for 13 machines for the last six weeks of the holiday season. These machines are capable of producing over 320 garments per hour depending on settings, so assuming they are producing at least 150 per hour on average, the holiday season revenue from these machines alone should be 150 shirts per hour*9 hour shifts*2 shifts per day *42 days in the holiday season *13 machines *10 dollars per garment in average = over $14m in revenue just from these machines in the holiday season alone, not including the production of these machines in the remaining 48 days of the quarter. This should create very impressive top line performance.

However this only accounts for the DTG2Go part of the business, management has guided to flat yoy in activewear for the first half. The first half of 2022 actually included Delta’s largest ever quarter of over $130m revenue in the March quarter, so the base activewear guide is quite bullish as well. For reference, if DTG2Go were to be flat yoy but activewear were to have a flat first half vs 2022, overall revenue would like to be over $120m, which would be something like 10 % overall growth.

In other words revenue will likely grow around 10 % this quarter just based on the management guide for activewear and salt life, and the statements around the Polaris machines mean that revenue growth will likely be at least 15 % this quarter accounting for some margin of error. Meanwhile the stock has been massively depressed by tax loss selling and industry dynamics.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.