Destination XL Group: An Undervalued GEM In Big And Tall’s Clothing Business (NASDAQ:DXLG)

Funding thesis

Vacation spot XL Group, Inc. (NASDAQ:DXLG) is a significant participant within the males’s huge and tall clothes enterprise, boasting the trade’s widest choice, having fun with quite a few unique partnerships with clothes manufacturers. Moreover, practically 25% of its market worth is held in money. Regardless of these energy, DXLG’s classification as a discretionary retailer is weighing on its valuation; DXLG presently solely trades at a price-to-earnings ratio of round 8. We expect this introduced an ideal alternative to affected person and worth based mostly buyers. When the market situation improves, we might count on the enterprise’s price-to-earnings ratio multiples to develop to not less than 15 to shut the valuation hole and gives 2X reward for buyers.

Moreover, this enterprise introduced in a superb administration crew that efficiently turned the enterprise round through the pandemic. That they had a stable enterprise progress plan for the subsequent three years, which is extremely prone to ship further worth to each its prospects and shareholders.

DXLG has a monopolistic like place in huge and tall clothes enterprise for males

At DXLG, huge and tall is all they do and so they promote males’s garments sized from 1XL all the way in which to 4XL solely. That they had 281 shops throughout 46 states in U.S. and 69% gross sales are transacted in shops whereas 31% gross sales transacted on-line. They’re the one completely huge+tall retailer in males’s attire.

In contrast to its opponents comparable to Goal (TGT), Hole (GPS), and Macy’s (M), who provide a piecemeal choice, DXLG gives a variety of choices that cowl any event, from informal to formal, and from value-priced to high-end designers. Their stock consists of over 5,000 kinds and options greater than 100 nationwide manufacturers. Moreover, they provide an unlimited assortment of unique nationwide manufacturers that may solely be discovered at DXLG, catering particularly to huge and tall prospects.

Moreover, the variety of unique collections is regularly increasing. In the course of the 2023 Q2 earnings name, the administration launched two further extremely sought-after manufacturers, Faherty and Hugo Boss, to their unique alternatives.

As I discussed on our final quarterly name, we have now two extra iconic manufacturers which can be stated to launch with DXL. I am more than happy to report that Faherty and Hugo Boss are each becoming a member of our portfolio of manufacturers this fall. Each manufacturers shall be accessible in chosen shops and on-line. Faherty is unique to DXL in huge and tall sizes, whereas Hugo Boss is delivering unique huge and tall product capsules, that means in each examples, you can’t discover this product anyplace else.

These large alternatives and unique collections have given DXLG two aggressive benefits. First, since nobody else provides such a wide array of unique merchandise within the huge and tall area, DXLG enjoys a really wholesome revenue margin. In fiscal yr 2022, they achieved a gross margin of 49.9% and an adjusted EBITDA margin of 13.5%. This means that they’ve pricing energy with their prospects and don’t want frequent promotions to maneuver their stock.

Second, due to their wide variety and unique collections, they’ve constructed a big buyer base, making it simpler to safe unique offers with extremely sought-after manufacturers. Common retailers could discover it more difficult to barter such unique offers on account of providing fewer incentives for these manufacturers. In truth, a big nationwide model, Outdated Navy, tried to enter the massive and tall class in 2021 however failed within just a year. This demonstrates how difficult it may be to determine a big presence on this enterprise.

DXLG has a superb administration crew

DXLG was a totally totally different firm earlier than the pandemic, however the brand new administration crew efficiently remodeled the enterprise through the pandemic. The next monetary metrics reveal the effectiveness of the brand new administration crew:

• The brand new administration has eradicated all debt.
• They’ve constructed a robust stability sheet.
• The enterprise is now producing wholesome money flows.

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(Creator’s compilation based mostly on information from the Firm)

One of many essential strategic choices made by the brand new administration crew in 2021 was to cut back worth promotions and reductions within the enterprise. The brand new administration crew clearly understands the energy of their enterprise within the huge and tall class. They carried out an experiment that demonstrated they might run the enterprise efficiently with out counting on promotions, and so they subsequently expanded these initiatives. This strategic transfer paid off considerably in 2021, because the gross margin growth enabled the enterprise to generate $70 million in free money movement, thereby strengthening its stability sheet.

Under is what the administration is saying about this strategic modifications made in 2021.

We made a strategic resolution to run our enterprise primarily promotional free, with solely two very quick public assessments of provides through the single most necessary promotional and transactional time of the yr for nearly all retailers. This was a marked departure from earlier discount-driven vacation approaches.

We solely provided non-public promotions at decrease {discount} ranges to drive retention and reengage lapsed prospects with none public open provides for Black Friday or Thanksgiving weekend. We really feel that this technique paid off as we had been capable of preserve a really excessive gross margin price in This fall whereas remaining trustworthy to our imaginative and prescient of repositioning the DXL model round differentiation versus discounting.

DXLG has a progress leg within the subsequent couple of years

The administration crew’s function is to make essential choices for the enterprise. They made the suitable resolution to cut back promotions within the enterprise and construct a robust stability sheet. After reaching this objective in 2022, they’re now making one other strategic resolution to additional develop the enterprise.

One other problem the administration crew recognized is that many shoppers merely aren’t aware of DXLG, and addressing this difficulty presents a major alternative for the corporate. The massive and tall males’s attire market is valued at $23 billion and is extremely fragmented, but DXLG’s present annual gross sales are solely on the $500 million degree. There’s a substantial underserved inhabitants of huge and tall males on this sector.

The brand new administration crew has reviewed the enterprise’s previous model consciousness advertising efforts and decided that they lacked alignment with the model’s distinctive positioning, leading to much less efficient advert campaigns. Subsequently, the administration crew expanded their advertising crew and invested in buyer notion research to help them in crafting constant and compelling model messages. What’s much more vital is that they now possess a robust stability sheet that allows them to put money into strengthening the model.

DXLG is presently a $550 million enterprise with an EBITDA of roughly 13%. The model consciousness advertising efforts are aimed toward growing buyer consciousness of DXLG’s companies and increasing DXLG’s attain to serve a bigger share of the $23 billion market.

The administration has beforehand made the suitable enterprise choices, and this new enterprise initiative seems cheap to us. If the model consciousness marketing campaign had been to underperform, we might count on the administration crew to make rational decisions, probably discontinuing this effort. In such a situation, buyers would nonetheless have a enterprise that generates $550 million yearly with a 13% EBITDA.

Valuation

We are going to base our enterprise evaluation on 2022 as a result of the gross sales information in 2021 had been inflated on account of pent-up demand and pandemic stimuli. 2022 represents the primary normalized yr for DXLG. We made the next assumptions when mannequin the FY`25 outcome: the general gross sales develop 30% due to efficient model consciousness advertising, the SG&A% will enhance 2%.

Click on to enlarge

(Creator’s compilation based mostly on information from the Firm and Creator’s personal projection)

Utilizing the above valuation mannequin, we noticed DXLG’s valuation may very well be between $700 million and $800 million. DXLG’s present market valuation is $260 million and it will present investor not less than 2.5X rewards.

Moreover, it is value noting that DXLG maintains a robust stability sheet, and its buyback program may have a constructive affect on its per-share monetary information sooner or later. It is necessary to spotlight that this facet shouldn’t be accounted for in our mannequin.

Threat

The brand new weight reduction drug hitting the market may disrupt the massive + tall enterprise

A brand new weight reduction drug would seemingly have a adverse affect on DXLG. DXLG is a retailer of huge and tall clothes, and a good portion of its buyer base is chubby or overweight. If a brand new weight reduction drug had been to achieve success, it may result in a lower within the variety of people who find themselves chubby or overweight. This could in flip result in a lower in demand for large and tall clothes. The administration crew has introduced an fascinating counter argument to the affect of the burden loss drug throughout FY’23Q2 incomes name and thought this might make a constructive affect on their gross sales.

In case you’re at 3x, you are going to possibly transfer to a 1x. So there’s, to begin with, a catalyst for as you weight loss program and drop extra pounds, you want new shut. The opposite half that’s fascinating, and I am unsure it is unlucky it simply what it’s, it actually requires life-style change. And so, I do not assume anybody intends to be on that drug endlessly. And in case you do not change your life-style, it sadly creates a yo-yo, and we have heard that already.

We consider that buyers ought to preserve a detailed watch on the affect of the burden loss drug available on the market.

Abstract

DXLG’s enterprise holds vital benefits over its opponents, boasting a robust stability sheet, wholesome money movement, and a well-defined progress plan for the subsequent few years. Nonetheless, the enterprise’s a number of is presently low as a result of high-interest price setting, which impacts its valuation. We consider that when market situations enhance, its multiples will naturally develop, offering potential upside rewards for buyers.

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