Slam Dunk Reopening Play Points to 100% Upside In Next 12 Months
I love out of favor and unloved stocks. I deliberately screen for stocks at multi-year lows. Hated companies that no one is looking at. A terrible looking stock chart combined with a hated sector is a recipe for outperformance. The contrarian way.
The search for hated stocks has lead me to the retail sector — specifically clothing retailers.
Retailers have been shunned by Wall Street as a dying industry. The Amazon Effect. If you talk to any trained analyst it is likely they will bring up Amazon as the reason why they don’t invest in retailers. That and operating leases. And with FASB’s new lease accounting standard, ASC 842, analysts automatically associate retailers with high debt levels due to the way operating leases are accounted for on the balance sheet.
But these fears present opportunity for contrarian investors. A way for us to outperform the Street through rigorous fundamental analysis on out of favor value stocks. Which brings us to the latest edition of my favorite new retailer and stock that I think could double over the next twelve months, Destination XL Group (DXLG).
Destination XL is trading near multiyear lows. The stock was recently kicked out of the NASDAQ due to a low share price as institutional investors were forced to dump the stock.
The management team has eliminated over $50 million in SG&A, reduced rent payments by $10 million annually, and stripped out COGS to a “bare bone” levels through the permanent furlough of over 1,000 store level employees and 100 corporate associates. As revenues return, a significant amount of these costs will not come back.
There will be significant pent-up demand for “professional” and “nice” looking clothing over the spring and summer months as COVID is eradicated. Management told investors in the last six days, comps are flat with 2019 numbers. The catalyst to shop is happening NOW.
As revenues return, costs will stay low, resulting in significant operating leverage. Management stated multiple times in the Q4 2020 call that they expect to see operating leverage in the coming quarters. Cash flow will be strong.
Destination XL remarkedly only burned $5.4 million during the year of COVID. This points towards managements astute nature of cost cutting and extreme focus on cash flows.
The pro forma market cap (taking into account the recent stock sale) is $53 million with an enterprise value of only $108 million. The Company has guided to $400 million in revenues with $18 million in adjusted EBITDA — which we think is a low-ball target. Adjusted EBITDA should easily double in 2022.
COVID has been a blessing in disguise. Ecommerce revenues have skyrocketed, providing strong foundation for a new online presence. Merchandise margins should increase as more sales are funneled online in the future.
We believe a fair value of $1.70 share is justified. This would represent a market cap of only $100 million and enterprise value of $161 million for a company that could potentially generate $450 million in sales and $40 million in adjusted EBITDA.
Destination XL is a “big and tall” men’s clothing store in the United States and Toronto, Canada. The clothes Destination sells starts with waist size greater than 38” and tops sized 1XL and greater. At the end of Fiscal 2020, Destination XL operated 226 DXL retail stores, 17 DXL outlet stores, 46 Casual Male retail stores, 22 Casual Male XL outlet stores and a digital business including dxl.com.
The Company breaks down revenue into three sections, Store Sales, Direct Sales and Wholesale. Store sales are sales that are initiated inside of a DXL store. Direct sales are sales that are sold through the Company’s online channel. Wholesale is sales done through a partnership DXL has with Amazon.
For context, each segment performed as follows in 2020:
In 2020 Store sales fell 50% to $180 million as the majority, if not all, of the stores were closed in the first half of the year due to COVID. Direct sales grew 15% to $122 million as customers bought the majority of their clothes online. Wholesale grew 32% to $16 million due to a surge in mask sales in Q2 and overall growth in the Wholesale segment.
Why there is opportunity
This is a turnaround microcap play. Operating history in the past has not been compelling. The Company has not generated positive net income since 2012 despite flat to growing comps. Cost have been extremely high as the Company transitioned their Casual Male concept (older, not as hip stores) into DXL stores, which are fresh, on-trend and hipster looking. In addition, there has been multiple restructurings and CEO transitions as the Company “footed” its way through the past years.
Despite the negative net income, the Company did generate marginal or breakeven free cash flows given the large depreciation expense that doesn’t show up on the income statement. Furthermore, if you back-out of the growth capex, it is likely the Company would have generated meaningful cash flows if they were not going through their reimaging transformation.
But looking backwards at the financials will only give you a glimpse into what has happened and not what is going to happen.
To survive the COVID storm, CEO Harvey Kanter immediately took the following actions:
Drew down $30.0 million of cash against our revolving credit facility on March 20th to preserve our access to cash.
Amended our credit facility on April 15th to improve our excess availability on both the revolver and FILO loan.
Furloughed entire store operations team and approximately 60% of corporate office employees. Eliminated 34 corporate positions permanently.
Instituted temporary salary reductions ranging from 10% - 20% for the management team.
Suspended Non-Employee Directors’ compensation for the second quarter.
Cancelled $148 million, at retail, in merchandise receipts for fiscal 2020.
Worked with vendors for extended payment terms.
Currently negotiating with store and corporate office landlords on rent abatements and deferments for April through July, due to the impact of shelter-in-place orders and store closures.
Eliminated capital improvement programs for all discretionary spend and non-essential expenditures.
Despite these necessary cost cuts, the Company’s stock price was slashed and Destination XL was de-listed from the NASDAQ. As the stock plunged to $0.20/share investors began to think the Company was on a verge of bankruptcy.
But the message from the management team was totally different:
Since the start of COVID-19, we have been aggressively positioning our Company to withstand the economic downturn in the apparel sector, to maintain our liquidity, and to serve our customers wherever and whenever he wishes to shop. As we prepare to turn the page on fiscal 2020 and look forward to fiscal 2021, I wanted to share with you, at a high level, our belief in fiscal 2021 of continued recovery. The steps we have taken in 2020 to manage inventory, restructure occupancy costs, and reduce our selling, general and administrative costs create greater operating leverage on a reduced sales base in our business model. These actions have also helped us to preserve liquidity. At November month-end, we had $20.6 million in cash and availability remaining under our credit facility of $13.6 million. - Harvey Kanter
This turnaround messaged has continued to be voiced, especially during the Q4 2020 earnings call.
While these decisions were difficult, the cost savings which have resulted will continue to benefit us in fiscal 2021 and beyond. The assessment of SG&A is an ongoing process but we believe our cost structure is now set up for success and offers us the opportunity for significant operating leverage. The reductions in corporate and store headcount, services and discretionary spending will remain in place throughout this year and our store rent reduction efforts will also continue. - Harvey Kanter, Q4 2020 Earnings Call
The management team at Destination XL is basically screaming that if sales come back, operating costs will not come back. This leads to one thing; significant operating leverage and free cash flow generation. And even better, management blatantly tells investors that sales have returned.
In February, our comparable store sales were down 33% to fiscal 2019 and for the first two weeks of March, our comparable store sales have improved to minus 16%. Over the last six days we have been nearly flat to 2019. This puts us at a comparable store sales decline of minus 27% for the first six weeks of the year. I tell you all of this not to create hype but to give you a sense of our true optimism. We believe we are starting to see a shift in consumer buying. - Harvey Kanter, Q4 2020 Earnings Call
Management pinpoints the surge in demand based on the following points:
Pent-up demand for new clothes: their customers are tired of wearing work from home clothing and want a new set of “going-out” clothes as the world begins to reopen. No one wants to associate the trauma of COVID with the clothes they wore during COVID.
Great weather: spring has come around the corner faster this year. Warm weather is always a catalyst for Destination XL as individuals want to refresh their wardrobes for the new season.
Stimulus checks: a new round of stimmy checks have hit the bank accounts. This is the roaring twenties with celebratory times.
As a wrap-up, our team expects Destination XL to grow revenues significantly over the course of 2021 and keep costs at barebones levels. This will lead to higher operating leverage and significant free cash flow generation.
Management has guided for Destination XL to generate $18 million in adjusted EBITDA for 2021. We expect capex to remain at barebones levels (under $5 million) as store growth plans are on halt. Working capital should be flat to down this year as old inventory is worked through. The Company should generate free cash flow which will likely be used to de-lever their balance sheet.
Post-2021, we expect sales to return to a more normalized level of $475 million with 4% operating margins. The Company is a full tax payer and has a deprecation expense of $20 million/annum. Capex should be relatively minimal (probably around $5-10 million per year depending on any ecommerce initiative). Using a discount rate of 14% (our estimated cost of capital) we arrive at a target share price of $1.70 per share. We should note that our discount rate is likely high (for conservative purposes) and investors should adjust the tax rate as necessary as Biden’s tax plan will likely affect all corporations without significant NOLs.
Operating costs may not stay as low as we expect, leading to a decrease in expected free cash flow.
COVID-19 or a different strain of COVID may reemerge, resulting in a decrease in sales.
A significant decrease in sales will lead to negative operating leverage, potentially resulting in a massive cash burn.
The Company has net debt and may not be able to meet obligations if cash flow does not return.
The Company trades under $1.00 and is on the OTC exchange. Shares are highly illiquid and volatile.
We think Destination XL represents an attractive risk/reward at the current price. We expect the Company to announce strong results over the next few quarters as sales return and operating costs stay low. Our target share price of $1.70 represents over 100% return from the current price.
Disclosure:I have a position in this DXLG and will buy more or sell the stock anytime. I am not a financial advisor. This is not financial advise. Do your own research. The article was not proofread by outside sources and some facts/statements may be inaccurate. Verify everything yourself and make an independent decision.