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 fulfilled their growth opportunities. However, the stock has fallen significantly. They are now far below 10x forward earnings despite two $50-$100m growth companies. Increase earnings by over 10%, and a $300 million+ activewear company that should be either flat- or growing.

Hanesbrands (HBI) may have contributed a significant amount to the fall. This is not fair as Hanes is primarily focused on basic apparel, while Delta is a decorator/distributor. Hanes is also international while Delta is North America-focused, which is another advantage for Delta.

Bull case supported by management activity. The company has hired more executives in the last few month than ever before 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. Mastercard reports that apparel sales rose 4.4 % for the holiday season. This is an inflation adjusted decline, but it 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.

Shoring Nearby

The UFLPA could also cause significant migration of the apparel supply chains into Central America, where DLA has its manufacturing facilities. Mexico’s GDP per head is almost as high than China’s, making it difficult for Mexicans to produce apparel. DLA’s manufacturing facilities in El Salvador, Honduras, and Honduras are prime targets for the UFLPA’s increased demand and changing global supply chains. This may result in increased revenue and incrementally better margins for apparel producers in North/Central America.

This is already happening As China’s November export data showed, China’s November export data showed that exports to the US were down 25% y/y. This is below October and further declines are expected. Trade.gov data shows that cotton product exports from China have fallen 30-50% in many categories since October. It looks like they will continue to fall, especially considering the November export data. Although China is less prominent in the cotton category than Honduras or CAFTA-DR, the reduction is still significant. This means that there is room for at most a 10-20% increase to this region. ASEAN is also down in certain categories, as the region relies on China for raw materials. The context can be added by looking at the Long Beach and Los Angeles container data.

The trend in Honduran export data shows that it is flat. However, this may be due to the inventory shortage. This could lead to a significant increase in exports once the inventory surplus is gone and supplies from elsewhere have declined further. It is unclear what part this noise is, however it seems at least partially structural, particularly considering the differences in US export data and EU export records.

Management stated on the conference call that Activewear will be flat in the first half of FY 2023, and will grow in the second half. They are also conservative with their revenue estimates. DTG2Go, Salt Life, and most likely over 15%, will all be growing double-digits. The outlook for next year should be around 5 % or better. Higher margin businesses will make up a growing portion of overall revenue. It is possible/likely that there will be a significant acceleration in trade dynamics once the inventory shortage is resolved in the next few months. This could have a positive impact on pricing and margins.

At this price, Delta Apparel is well below its tangible book value. While it is possible for DTG machines to be discounted, it is also possible their real estate will be worth significantly more that what is shown on the balance sheet.

There are risks

Delta Apparel’s biggest risk is the possibility of further market share erosion in its basic apparel business. This is their lowest-margin business, but it makes up a small part of their overall income. However, it is their biggest revenue business. Global brands comes in second. In the next year or two, however, the global brands business is likely to surpass the basic apparel business. They have been able so far to grow their other business lines sufficiently fast to compensate for the erosion of their basic apparel business.

The shoring-driven demand for manufacturing in this region should boost the basic apparel industry, but this is unlikely to be a problem in the immediate future.

Liquidity & Leverage

Delta finances its inventory mainly with debt, which results in significant debt on the balance sheets. This can be a concern for investors. It is important to realize that this debt is backed up by highly liquid, in-demand inventory which is being quickly 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 does not need funding. In fact, their share count has decreased over the years rather than diminishing. If Delta ever needs cash fast, they can reduce apparel production and bring their existing inventory to the market. This will allow them to quickly reduce their asset-backed debt.

Rising interest rates in 2023 will be a problem, but it should be a temporary effect of $1 per share in earnings, or less, and not enough to justify a major change in the company’s valuation.

Present Outlook

The immediate future is very likely for Delta to have its best quarter in DTG2Go. Because of the management commentary on the conference call, you can get a detailed view of the revenue they will generate from the Polaris machine they purchased. They stated that they would be running two shifts of 13 machines over the 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 produce a very impressive top-line performance.

This only covers the DTG2Go portion of the business. Management has urged flat yoy for activewear in the first half. The March quarter saw Delta’s largest quarter ever, with over $130m in revenue. Therefore, the base activewear guide is very bullish. If DTG2Go was flat yoy, but activewear was flat in the first half of 2022, total revenue would be more than $120m. That would be around 10 % overall growth.

This means that revenue will likely increase around 10 % in this quarter, based on the management guide to activewear and saltlife. The statements surrounding the Polaris machines suggest that revenue growth will likely be at minimum 15 % in this quarter accounting for some error. The stock has been greatly depressed by industry dynamics and tax loss selling.

Editor’s note: This article only covers one or more microcap stocks. These stocks come with risks.