DLTH - Duluth Holdings: Sell While You Can

2023-09-19 08:11:48 ET

Summary

• Duluth's stock is performing poorly and has lost over $2 per share in recent weeks.
• The company is struggling with falling sales, declining gross margins, and elevated promotional activity due to excess inventory.
• Estimates continue to move lower, and the stock is nowhere near cheap enough to account for its fundamental issues.

Retail stocks have been pretty weak so far in 2023, although there's been some relative strength during this recent period of market consolidation. However, that strength has certainly not been spread evenly, and apparel stocks have been laggards for the most part.

One such laggard is Duluth (DLTH), the maker of outdoor apparel that peddles its wares with memorable, irreverent adds. The stock is getting crushed, but even so, I think Duluth has enough problems that even at under $6, I'd steer clear.

A failed rally

Duluth has lost over $2 per share in just the past few weeks, and while there's some reason to believe we may see a bounce, it appears that would simply be a reason to sell.

We have the 20-day exponential moving average under the 50-day simple moving average, which is a very bearish sign for the intermediate trend. On the plus side for the bulls, both of the momentum indicators are well into oversold territory. The stock has been destroyed, so that's unsurprising, but with the PPO at -5, it's possible the selling stops simply because there's been so much selling to this point. That, however, is not a reason to buy the stock; it simply means sentiment is quite negative.

Now, there is a double bottom in place at $5.11 from May, which is another 60 cents lower from here. I would not be surprised to see a test there, and if so, a meaningful bounce should result. Right now, the stock is a bit in no-man's land between support and resistance, and as I said, I just want to steer clear at the moment.

Fundamentals are a hard pass

In retail, there are a few things that really matter. Revenue, SG&A, gross margins, and inventory are massively important and determine the company's ability to be profitable, but Duluth is struggling on a lot of these measures.

The company posted earnings a couple of weeks ago, and it was more of the same. We saw sales fall, particularly in the retail stores due to lower traffic counts. In addition, gross margins continue to fall due to elevated promotional activity, which is driven by too much inventory. SG&A costs also rose as a percentage of revenue, meaning Duluth lost ground on everything that matters.

As we can see below, this is hardly the first time. Revenue and the revenue change rate are below in trailing-twelve-months for the past several years.

Duluth's revenue growth rate went negative last year, and hasn't yet gone back to zero. It will at some point as the comparable base continues to decline. But even so, all of this top line damage has harsh implications for margins.

Here's the look at gross margins and operating margins, and it doesn't look much better.

Gross margins have deteriorated pretty meaningful recently, which has taken operating margins to essentially nothing. So long as Duluth continues to cede top line growth, it will almost certainly continue to promote to move product, which is going to take a further toll on operating margins.

As I mentioned above, Duluth has an inventory problem, and we can see the days of inventory outstanding below.

The spikes you see each year are for the holiday quarter, and that's normal. But you can see days outstanding inventory has crept higher and higher over time, and stands at a staggering 186 days right now. In other words, Duluth has a full six months of sales sitting around on its balance sheet, which is simply too much. This is why the company promoting product to unload it, so on that evidence, days of inventory outstanding probably could have been worse. There's no way to defend having this much inventory, particularly for an apparel retailer, where styles generally have short life spans. That leads to promotion to unload old product.

Here's the thing; so long as Duluth is struggling to generate demand with its stores, it will continue to have an inventory problem, which will drive its margin problem. I don't see any cause for optimism here, as the company's strategic moves in the past, such as going heavy into female clothing, provide decent, temporary bumps but not sustained growth.

Estimates for this year are now for a fractional decline in sales to drive a much more sizable decline in earnings.

Analysts are looking for a rebound into 2025, but that's based on estimates that have been steadily revised down . I have a hard time believing the spiral of weak demand driving promotions driving lower margins is done just yet, so I would honestly be surprised if 2025 saw any earnings at all.

It's cheap, but is it cheap enough?

Since Duluth has no earnings, we have to use price-to-sales, which is far from perfect.

We can see shares are at 0.32X forward sales today, which is well off the high of about 1X sales set two years ago. The thing is that P/S is a function of profitability, and two years ago, Duluth was making a lot of money. Today? Nope. That simply means that in the context of a company with too much inventory and negative margins, I'm not sure 0.32X forward sales is any sort of cheap. Indeed, it could get a lot cheaper if this cycle lower in demand continues.

The bottom line here is that Duluth has a lot of problems that start with weak demand. The direct-to-consumer segment is doing better than the stores, but that's a hollow victory given how weak the stores have been. But when I look at an apparel retailer with six months of inventory, a constant need to promote to move product, and negative operating margins, there's really no price where I'm interested. I think Duluth is a sell.

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