Some Thoughts Amidst Recent Price Delta ($DLA)
There should be big news soon.
Dear Readers,
The recent Delta Apparel ($DLA) quarterly report showed that higher priced cotton inventory is still flowing through the income statement. As management reiterated in the earnings call, performance should show meaningful improvements in the second half of this new fiscal year. So far the company has donde a decent job at reducing inventory and debt, even this last quarter where there was less demand. Both should continue to lower and inventory should stabilize between $200-150m.
Nonetheless, I believe that there is evidence that Delta is preparing for something unusual and material. Here is what has distracted me lately:
1-. The company intended to sell 2 properties they own since October and announced the final sale on November 29 for a total of $31.5m. Credit agreement amendments show that they had agreed with their lenders to sell the 2 properties by January 2024. Delta only owns 6 properties with a book value of $69m and has never sold in the past any substantial portion of their properties. Why would they sell almost half of their properties by value when they will be unprofitable in the near term? Interest expense on their debt has almost doubled since 2019 which will wipe substantial future profits. Again, why would management decide to add another expense which will shrink more their already thin profits from the activewear segment? Management who operate businesses which struggle to generate real earnings and own substantial real estate typically avoid to enter into leaseback transactions because it will make their job harder. They filled the credit agreement amendments after they received the unsolicited bid for Salt Life.
This comment from a former shareholder in Value Investors Club encapsulates my last point:
“I would also point out that valuing these assets independent of their contribution to margin is dangerous... i.e. the business is already struggling to produce profit without Salt Life, so if you do a sale-leaseback of real estate, their profitability is negative... suggesting the remainco isn't worth much standalone (although it likely would be to a strategic.)”
Another VIC member added the following:
“Why do I think there is an exit event? I once asked Bob [CEO] "if we're talking in five years and the stock has done very well, what happened? And if we're talking in 5 years and the stock has done poorly, what happened?"
Bob "Well, I hope I'm not still running this business in 5 years"
Bob is 65 possibly 66.”
Assuming this last exchange is accurate, this sale-leaseback should be a specially good sign. Could they be preparing for a sale of the activewear business to a strategic or reducing reducing unmanageable debt?
2-. As I quoted before, Bob is 65 years old and owns 458k shares which are worth $3.2m at today’s share price and 2 years ago they were worth $14m. Assuming the exchange I quoted above is real, it is unlikely Bob wants to work for another few years until the stock price hopefully increases to more than what he could get in the private markets theses days. This is assuming he doesn’t think the stock could trade at near the all time highs anytime soon. I don’t think the business’s operations have been permanently impaired, but the new interest rate environment puts a lot of pressure to the activewear business.
3-. Bob explained in the latest earnings call that the strategic review is still being conducted and he reiterate the board remains focused in maximizing value for shareholders.
Let me spend a moment on our Salt Life business. As you likely saw in a press release we issued in October, we received an unsolicited offer to purchase that business, and we are conducting a thorough review of our strategic options. We do not have a specific update on that review process at this time, but I want to reiterate that our Board of Directors and Management team are committed to maximizing value for Delta Apparel shareholders, and taking the course of action we believe is in their best interest. We look forward to updating you once our Board of Directors has completed this process.
He then added a message that had some resemblance to a farewell note:
I would like to recognize all the hard work put in by the Salt Life team to grow their brand into the highly profitable $60 million business it is today. It's amazing to think that Salt Life was basically a Florida brand with a small wholesale business when we acquired it 10 years ago, and now has a growing core of enthusiasts throughout much of the Western Hemisphere as well as a comprehensive product line offered to us over 1,700 wholesale doors across the United States and direct-to-consumer customers by our e-commerce site shipping to all 50 states and branded retail stores spread across most of the U.S. coastlines.
I am more unsure about Bob’s intentions with this last comment so please be more skeptical than usual here. Clark Square Capital was the first to notice this and from whom I generated this idea!
Lastly, Delta reported their 4th quarter 20 days later than their usual date and recently filled with the SEC announcing they would file their 10K within 15 days after the prescribed due date for different reasons. Their explanation was the following:
“Delta Apparel … was unable to file its Annual Report on Form 10-K for the fiscal year ended September 30, 2023 … within the prescribed time period … because the Company requires additional time to complete certain processes and procedures to finalize the Form 10-K and work through certain matters related to its satisfaction of the availability and related covenants contained in the recent Twelfth Amendment to the Fifth Amended and Restated Credit Agreement (the “Twelfth Amendment”) the Company entered into with Wells Fargo Bank and the other lenders set forth therein and other matters related to that agreement.”
The reasons should mostly be about the sale-leaseback transaction and completion with this new covenant included in the latest credit agreement. It shouldn’t be very related to the strategic review. Regardless, I think these 3 points highlight that there could lead to a sale since Delta initiated the strategic review.
On another note, these days I am finding the aircraft leasing very interesting, specifically AVAP as I have noted in the past.
Fernando