Delta Apparel Stock

Delta Apparel, Inc. (NYSE:DLA) continues to steadily build a very valuable and scalable business in apparel logistics and the market is completely sleeping as the stock is valued <10x earnings with ~20%+ earnings growth for the foreseeable future. DLA has remained cheap for six months now, as the market continues not to appreciate that it is much more scalable and much more defensible than a typical apparel company. It should also have extremely well protected downside from its activewear business.

Capacity Expansion

Most importantly, DLA specified in their March 15th presentation their medium term plans for capacity expansion. They plan to expand capacity >10% per year for the next few years, having expanded capacity just under 10% this year already. This is very bullish as well as it implies ~20% earnings growth, accounting for the higher margins at DTG2Go and Salt Life, operating leverage, as well as the possibility that they may not use all of the new capacity.

Fanatics

On March 28th Delta announced that Fanatics will be moving on to the DTG2Go platform. Fanatics revenue is ~$5 billion with the majority of it apparel. Revenue has compounded >20% and the company is valued at $27 billion. They also may go public relatively soon which may bode well for their appetite to ramp DTG2Go quickly to add as much additional revenue as possible.

The potential revenue to DLA is very material. In 2020, Delta announced Hot Topic as a significant new customer with only one shared distribution center. Fanatics was just fully made public today and already has four. It would be surprising if DLA realizes less than $40 million in revenue from Fanatics at least, with potential for nine figures. DLA is already producing significant revenue from Fanatics (printing the Super Bowl apparel for the Los Angeles Rams after their win) so some of the new revenue is likely already reflected. If DTG2Go can ramp to $100 million of revenue with Fanatics and compound 25% per year from there, DLA stock should more than double. The marginal profit from DTG2Go should be around 15-20% of revenue, so this would be a doubling of DLA profit within 2 years. Importantly, Robert Humphries specifically said that he expects Fanatics to grow into their largest customer. They currently have no customer over 10 percent of revenues, though they do have very large customers like Nike, so imagining that they currently have one customer at least 7% of revenue, or $30 million, it’s reasonable to expect that Fanatics is likely to be at least $40 million and grow from there.

It is possible that Fanatics has decided to completely replace in-house digital printing by outsourcing to DLA. At Roth on March 15th CEO Robert Humphries stated that big users of DTG2Go are closing their own facilities to transfer entirely to DTG2Go. This is very possibly Fanatics as we know that Fanatics does have digital print technology and we know that DLA has been very focused on the professional and university sports apparel market based on recent conference calls. It also may not make business sense for Fanatics to have both a significant in-house digital printing operations and four co-located digital printing facilities with DLA. All these point to Fanatics as potentially having replaced the majority of their digital printing capacity with DTG2Go. A good example of Fanatics’ products that would be digitally printed can be found here in their custom shop.

The Fanatics partnership is catalyzed by DLA being able to digitally print in such a way that it is indistinguishable from screen printing. The company has been mentioning this breakthrough over the last several earnings calls. It is also important that they achieved this breakthrough with a company other than Kornit as it helps to show that DLA has a technology and logistics platform that is wholly independent from Kornit.

In a conference on March 28th Robert Humphries stated very specifically that he expects other large customers to begin to more heavily use the DTG2Go system as well. The fact that one very large user decided to shut down their own facilities (either Fanatics or someone else) to use exclusively DTG2Go should bode very well no matter how you look at it.

Salt Life E-commerce

DLA has another very scalable high margin business that the market is sleeping on. Salt Life e-commerce probably has the highest operating margin of any of DLA’s businesses around 20%. The potential to scale Salt Life via e-commerce is extremely large as DLA has world class e-commerce infrastructure in DTG2Go and Autoscale AI that they can build on. They also have a significant portfolio of physical stores. There are many e-commerce brands with no physical stores at all that sell hundreds of millions of product online, and combining these two things it is likely that Salt Life achieves nine figures of e-commerce revenue.

Management has begun to call out Salt Life e-commerce in quarterly calls and shareholder conferences as they did today. And it seems very likely that Salt Life will eventually achieve this. Every $100m of Salt Life e-commerce sales is roughly an incremental $20m of EBIT for DLA. This is however a 3-5 year event as management has only just begun to discuss it and is currently focused on DTG2Go and capacity expansion.

Mitigating Factors

There is significant cost inflation including shipping, energy, and cotton. Cotton has gone up dramatically, though hopefully will not stay elevated for too long. All of that in mind, management stated at the recent conference that they have been able to raise prices to compensate for these increased costs. To some extent DLA may experience operating leverage due to cost inflation if they have room to raise prices.

Medium Term Financial Outlook And Valuation

The core activewear business is growing units in high single digits and pricing ~10%.

At the conference today management stated that they are seeing high single digit unit growth in the legacy activewear business, coupled with pricing increases over 10%. Salt Life and DTG2Go should each grow over 25%, with those two accounting for roughly $150m of revenue between them. It is starting to look like overall revenue growth for DLA may come in above 15% for the year, though management is too conservative to say so. This means revenue is likely to be $500m or maybe a little more. Inflation pressures will definitely pressure margins, but Robert Humphries stated at Roth that his commentary on the most recent quarterly call was probably too conservative. However the price of cotton has continued to climb which will pose renewed pressures, though that could reverse any time. On the other hand the growth of DTG2Go should be a significant positive for margins, and it is likely that factors like the price of cotton will be relatively transitory.

With all this in mind it appears likely that DLA will meet or exceed Telsey Advisory Group’s estimate of $3.43 this year, especially considering the addition of Fanatics and other large customers to DTG2Go. It has generally beat estimates very consistently so this shouldn’t be a surprise.

This means the stock is currently below 9x PE, and is dramatically undervalued compared to its historical average and on any reasonable DCF model. It remains unreasonable for a stock to trade <10x PE with ~20% earnings growth and excellent downside protection. A more reasonable valuation would be 12-15x $3.4 2022 EPS or $40-$50.

In addition to the downside protection from the stable nature of the athletic apparel industry, there is downside protection from diversification. For example, DTG2Go should surpass $100m revenue with 15-20% operating margins in the next 1-2 years and Salt Life ecommerce is likely to also be able to surpass $100m revenue with 15-20% operating margins over the next 5 years. Those are both very scalable, decently high margin business, and should each be worth more than $100m based on those prospects, yet the entire market cap is below $200m and that includes a very large activewear business growing almost 10%.