Duluth Holdings: A Risky But Worthwhile Growth Story

| About: Duluth Holdings (DLTH)

Summary

Duluth Holdings, off of a recent IPO, has a solid foundation for growth for the next 2-3 years.

The company is set to diversify and expand into brick and mortar stores, as well as women's clothing.

A combination of brand power and customer satisfaction sets Duluth apart from competitors.

A seasoned management team that is highly vested in the company is reassuring for investors.

Background

For those unfamiliar with the company, Duluth Holdings Inc. (NASDAQ:DLTH) is a lifestyle brand of clothing, work wear, and accessories. The company sells all of its products through its own channels, operating through two segments: direct and retail. Direct includes sales from the company's website and catalogs, while retail includes sales from its 8 (soon to be 9 in June 2016) retail and outlet stores in Minnesota, Iowa, Wisconsin, and South Dakota. The company was founded in 1989 and is headquartered in Belleville, WI. Duluth Holdings Inc. IPO-ed on November 20th, 2015, at $12/share and has risen since to $16.50. A couple catalysts that make Duluth a buy:

Expansion From Online To Brick & Mortar

Although only 10% of net sales come from Duluth's physical stores and the rest from online, that could soon change, as the company claims that it could open up to 100 stores in the future. This may seem out of reach; however, keep in mind that competitors Boot Barn (NASDAQ:BOOT) and Tractor Supply (NASDAQ:TSCO) own 200+ and 1,400+ stores, respectively. The company has a distinct advantage in that, as it sells its own products, it controls its own pricing and marketing. As its in-store retail sales grow, it only deems to benefit from diversification of sales channels. As of now, the company plans to open 4 more stores in 2016, 6 in 2017 and 8+ in 2018.

Brand Power

This is one of the largest catalysts behind why I believe Duluth Holdings is well positioned for (dare I say rapid) growth. Not only does Duluth have a premier product in its industry (customer satisfaction is at the top of its class), but it works in an industry with some of the most loyal customers in the retail business. The company has a very balanced geographic sales mix in the US (top three customer bases are California, Texas, and New York), and sales are balanced between product types as well (55% of top line comes from tops/bottoms, the rest from underwear/outerwear/footwear/accessories). I can tell you that I, along with several of my hunting comrades, own a pair of the men's Fire Hose Superior Insulated Bibs, and after being a Cabela's (NYSE:CAB) die-hard my entire life, I don't think I will ever buy another pair of snow pants that are not Duluth. It held up better than every pair of snow pants I have ever worn while duck hunting. Quality is important to this segment of customers, and the argument of whether Duluth could be a "fad," as we find so much in the clothing space, gets pushed farther and farther away for me as I find myself continually uncovering stories of great customer service and quality product experiences. It has signature products that are unique to different outdoor activities (think Long-Tail Tee or the Buck Naked Underwear), and it has a strong marketing message that gives the company personality.

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(Source: BMO Capital Markets)

A Solid Financial Foundation For Growth

Duluth Holdings reported its first round of earnings as a public company in December, and it did not disappoint. Revenues came in at $163.8m for the 9 months ended 11/1/15, up 34.5% from the year prior. This was driven by gains in both the direct and retail segments across all categories. Management notches that up to marketing (you can most likely recall its humorous and lively commercials), and totes website visits up almost over 30% from the year prior. Gross profits followed suit with the top line increasing 36% from the year prior up to $94.7m, and gross margins saw a bit of an increase as well to 57.8%. Now for the not-so-great news… SG&A popped up to $24.9m (up 42% from PY), almost half of which was driven by its marketing efforts, with the rest coming from an increase in labor. These higher costs translated into net income staying relatively flat, increasing just 1.5% to $9.9m for the 9 months ended 11/1/15. Operating cash flow saw a decrease; however, these are Q3 numbers, with a large portion of sales coming in the holiday season/Q4. At this point, I'm fine with these operating cash flows, as any rapidly growing retail store would be expected to be building inventory ahead of the holiday season. As far as the balance sheet goes, I'm not all that excited that almost half of the proceeds from the IPO basically got paid out to past shareholders; however, one more monkey off of DLTH's bank as it aims to expand is okay by me. One more thing to point out - not that I love using P/E as an investment catalyst, but DLTH's price comes in at 16.82 of its earnings, below the industry average, while it can be argued it has the most room to grow of any of its competitors. I expect margins to remain thin as the company continues to ramp up marketing efforts, increase its labor force, and open new stores; however, if this brand sticks around (which I believe it will), it will be very well positioned in its industry to continue to grab market share from competitors.

Stephanie Pugliese And The Push Towards Women's Clothing

Stephanie Pugliese took over as President and CEO of Duluth Trading Company in February of 2015 and brings over 22 years of retail leadership experience to the table. She helped launch the women's line of Duluth in 2010 and has spearheaded marketing and product development at the company. Before joining the company, she held roles management roles in Land's End and Ann Taylor, and her experience will help serve her well in promoting Duluth's women's line of clothing (which now accounts for less than 20% of the top line while the industry average is 60%). It has to be reassuring to an investor as well that not only Stephanie but the rest of the management is highly vested in Duluth. Officers and directors own 67% of all shares outstanding, showing that there is a belief at the very top that this company is destined to succeed.

Possible Downsides

As with all retail businesses, the "fad" argument is ever-present. However, Duluth has found a permanent place in my closet after just one purchase, and I would hope to believe many others feel the same way. There is also the risk that its marketing push and opening of new stores fail to drive the top line. At the end of the day, Duluth simply is just not as well known as Cabela's, Carhartt, and many other competitors. It has carved out a small percentage of market share, but if its brand doesn't stick, it will negatively impact financials. There is also a risk that as the company grows, distribution will suffer. As its retail business grows, it will be key to pick locations that suit its demographics as well.

Conclusion

The risks are there; however, I believe Duluth has positioned itself well already in its retail space and has set itself up for rapid growth in the next 2-3 years. It has a seasoned management team with vast knowledge of what it takes to succeed in higher-end retail and has a solid financial base to expand on. Duluth also has a strong (yet small) and loyal customer base that only has room to grow. If you have a riskier palette, Duluth is a viable play in the retail space.

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.