Delta Apparel: Affected By Demand Slowdown And Inflation (NYSE:DLA)

The US-based Delta Apparel, a casual and athletic wear company, is the most affected by current macroeconomic conditions.NYSE:DLAIt would be (). Its recent results for the first The company mentioned rising costs as a result of persistently high inflation numbers, and weakness in demand which are also explained by subdued economic development. Its financial results have been poor in the quarter ending December 31, 2022.

What the stock market movements reveal

This does not mean that the US company, which produces blank apparel under Delta Group as well as lifestyle apparel under Salt Life branding, should be ignored. The ratio of its GAAP price to earnings (P/E), for the trailing 12 months, shows that it stands at 6.4x. Significantly lower than the 14.5x average for the entire consumer discretionary sector.

This indicates that there is a possibility that its stock price might have overcorrected despite the fact that it has actually risen year-to-date, by 4.5%, and by more than the S&P 500 (SP500) (see chart below). But its performance is still underwhelming compared to the 9.65% increase in the S&P 500 consumer discretionary index. The stock actually fell more than the sector index’s 24% decline over the last year.

This is where I look closely at the financials of the company to determine if it has the potential to increase its stock price in the future.

The company

Delta Apparel serves a growing market. The US market for athletic wear is worth USD 8-10 billion. Global growth is predicted to be 6%-7% in the next ten years. The company had a 11% increase in revenue for FY22. This was clearly a good sales performance and it was profitable up until recently. The company’s recent stock price movements show that this isn’t the entire story.

Recent performance is poor

The company’s latest earnings release may give some clues to the reason for this. As demand declined for mass retail supply chain, the company’s Q1 FY23 sales fell by 3%. For context, 87.6% came from the Delta Group segment, which consists mainly of wholesale and retail sales. The rest comes from e-commerce and retail operations (see table below).

Its direct-to garment printing business DTG2go as well as Salt Life brand saw significant growth, with their respective sales increasing by 20% & 17%, respectively. Salt Life has seen a lot of positive growth. It is a small percentage of overall company revenue at 12.4%, but it is encouraging. However, the positive impact of these segments was not enough to drive overall sales growth.

However, the company saw an increase in costs partly due to new store openings and also because its profits shrank due to the higher cost of raw materials like cotton. Its gross margin decreased sharply to 12.7%, from 20.8% last year. It also experienced an operating loss.

Potential positive developments

However, the company could see a turnaround going forward. First, if inflation continues to be as anticipated, it could see its cost numbers improve over the course of 2023 which could lead to a rise in profitability. A series of initiatives have been planned by the company that could help improve its financials. These include reducing costs as well as increasing revenues.

Delta Apparel intends to reduce its dependence of textile fabrics imported from abroad and scale up existing facilities in order to cut costs. It plans to move some of its production from Mexico to Central America. It is also looking at improving labour efficiency, which could lead to higher production at a lower cost. These measures are expected to lead to savings of USD 6 million per year, which represents 7.4% of its operating expenses as of FY22.

Another initiative of Delta Apparel is to increase pricing for printing services and blank garments. This can help customers pass on the savings and increase revenues. It is noteworthy that Delta Apparel has set a goal to reduce inventory, given the 41.4% increase of inventory levels in Q1 FY23 over the same period last year. It is especially important because its quick ratio of 1.9x looks stretched. It was higher than expected in Q1 FY22 but it declined to 1.4x.

Stock assessment

These numbers show why Delta Apparel isn’t a favorite among investors right now. It is risky due to falling sales, rising inventories and losses. Even though it has reported losses in two quarters, its P/E ratio of 6.4x seems very low. Its price to sales (P/S), at 0.2x, is comparable to the sector’s at 0.8x. This makes it competitive. It is, however, not for the right reasons.

Next?

I believe there is potential for the company’s performance to improve under better macroeconomic conditions. Its results for the last year are a clear indication of this. Additionally, the balance sheet of the company looks good, despite its increased debt. It is possible that the stock would rise if inflation or growth numbers improve. The economy is unlikely to improve in 2023. In fact, it’s looking to be quite opposite. There are more risks of recession and even though inflation is on the decline, it remains to see when the interest rate rises will end.

For the moment, I will hold off on buying stock. However, it’s not a sell. It isn’t a lost cause. The company is simply going through difficult times at the moment. It’s a wait-and watch.

Editor’s note: This article only covers one or more microcap stocks. These stocks can be dangerous.