Duluth Trading: Downtrend Is Done – Duluth Holdings (NASDAQ:DLTH)

Duluth Trading (NASDAQ:DLTH) has started off the fall season with a bang. Great Q2 results, as well as a new CFO with significant experience, bode well for the rest of the year. The company added Dave Loretta, who was most recently CFO of Nordstrom Bank for four years, to an already strong management team. He is already up and running with DLTH, taking part in the conference call even though he is in a brand new role just as of a few weeks ago. Having the transition happen quickly is essential for the short-term stability of results, so this is a positive development for Duluth. 15 store openings are expected in both C2017 and 2018, continuing to drive retail and brand expansion. I will now dive deeper into the strong Q2, where growth in many areas exceeded analyst expectations.

Revenue was a nice upside surprise in Q2 with growth of 31% from Q2 in 2016 at $86.2m. With an expectation of $82.5M, this was a nice beat on the top line of several percent. My most favored metric adjusted EBITDA was up 27% y/y to 9.5 million. Shipping has been weighing on the gross margins of Duluth and should continue to do so in the future. The retail market is competitive, and consumers often expect free shipping. When the difference between a sale or not is shipping cost, it has become an area of margin compression for clothing companies. Over the longer term, this will impact margins less as retail becomes a larger percent of sales versus DLTH’s strong online presence. The good news as far as gross margins is that core products saw an uptick in sales, with product sales margin actually increasing itself. When you back out the impact of the additional free shipping promotions, online sales increased 10% y/y.

Management went into some fine detail on how it believes retail stores increase awareness of the brand as well as sales online in those cities. CEO Stephanie Pugliese noted “25% of our end customers year-to-date have been acquired through our retail stores.” She also said that up to 50% of the new store customers were first time purchasers of the DLTH brand. This is showing the synergistic effect of the retail stores in providing knowledge of the online product to those without it. Men have 11% greater awareness of Duluth in areas with a retail store, and women an impressive 26% higher. These are good, long-term numbers as the company continues to build out 15-20 stores a year over the next several years in key markets. The growth in retail stores has DLTH expecting almost 30% of total C2017 revenue from retail, continuing a strong brand expansion. You need to know a product exists before you can buy it, and Duluth is doing a good job among those who have tried the products. Many people want to try on soft goods before they purchase, and now a much larger portion of the customer base is able to do that.

With guidance of $460m revenue and $48.25m adjusted EBITDA at the midpoint, the growth rates are reasonable for the current $20 price. Keep in mind at a 39% tax rate also, any movement on tax rate would have a nice benefit for DLTH as well. Longer-term operating margins of closer to 10% to 12% should give a nice EPS upside in a few years’ time. Operating margin in the quarter was 8.57%, so 30-50% upside is possible after store opening costs become a smaller part of revenue. Be aware that the short interest is sizable in this position, and the risk here is elevated due to the sector. However, a
$30 target is quite reasonable in a 12-month time period, good for 50% upside a year out.

DLTH data by YCharts

As you can see from the above chart, the stock has leveled off and made a nice move even while its retail peers have continued falling. The recent positive quarter should provide additional lift heading into the important fall months. This is a period that DLTH may have volatile sales due to weather, but management is prepared this year. It has set itself up for a strong Q3 irregardless of what it looks like outside. Also, the store runway is just beginning and should provide a continued strong growth rate over the next 12 months. I would recommend buying Duluth Trading here before it reaches levels where it was previous to its fall. The stock should continue to be volatile, so buying it on any retail fears should provide for additional upside in the name.

Disclosure: I am/we are long DLTH.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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