Duluth Holdings (NASDAQ:DLTH), which sells casual clothing and workwear under the Duluth Trading brand name, finished 2016 on a strong note, yet its share price has fallen back near its 52-week low. In fact, since third-quarter results were announced in early December, the company's market cap has been cut by roughly 45%, with a bouncer after Q4 results not erasing the pessimism that set in after the Q3 report.
There seems to be a growing disconnect between Duluth's performance and its share price. The company increased sales and adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) more than 20% in the most recent year and has a long runway for growth. What's going on here?
During a retail apocalypse, Duluth is still thriving
Unless you've been living under a rock, you've likely heard about the serious challenges facing the retail industry: It's in the throes of a massive consumer shift to online shopping, and brick-and-mortar retailers are suffering. Already this year, The Limited and Payless ShoeSource have filed for bankruptcy protection, adding to the hundreds of store closings already announced by Sears Holdings subsidiaries Sears and Kmart, J.C. Penney, Macy's, and others.
As a result, expectations for retailers not named Amazon have been lowered across the board. So far this year, Standard & Poor's has lowered its ratings on retailers 20 times, anticipating "increased levels of stress for the sector in 2017" and noting it expects "at least as many defaults as in 2016."
Against this gloomy backdrop, Duluth increased its retail sales a robust 76% last year, as the company continues to aggressively expand its retail footprint from its current small base of 19 stores. And with as many as 100 potential locations planned, there's plenty of growth still ahead.
Additionally, Duluth owns all of its distribution, so there's no risk that another retailer carrying its products will close stores. The company's products are unavailable anywhere else -- including on Amazon -- so as long as those products remain differentiated and in demand, Duluth should be able to continue growing at healthy rates.
But a border adjustment tax could hit Duluth hard
You've probably heard that Congress is considering something called a border adjustment tax (BAT), which, among other things, would eliminate tax breaks for U.S. companies that import goods from foreign countries. While there's no consensus on the impact a BAT would have, it could be particularly bad news for Duluth, as it manufactures nearly all of its products in China and other parts of Asia.
If importing its clothing suddenly became more expensive, Duluth would be forced to raise prices, allow its margins to suffer, or a combination of the two. Unsurprisingly, retailers are largely opposed to the measure, with the National Retail Federation launching a new campaign recently attacking the BAT as especially bad for small businesses.
The outlook for a BAT becoming reality is unclear, but with Duluth's stock price continuing to languish even after a solid fourth-quarter and strong 2017 guidance, it appears the market is continuing to price in a lot of uncertainty on this front.
Are investors being short-sighted?
How much would you pay for a company looking at long-term annual revenue growth of 20% and net income growth of 25%? How many companies even have those kinds of prospects? Those are the financial targets Duluth's management believes are achievable. However, the company has noted its profit growth will not be as robust over the next 18 to 24 months as it makes substantial investments in building out its brick-and-mortar presence.
The midpoint of Duluth's 2017 guidance range reflects top-line growth of around 22%. Analysts are slightly more bullish -- with average sales estimates of $464.5 million for 2017 coming in at the high end of company guidance.
A company growing at rates like these rarely sells cheap, and Duluth's stock probably got ahead of itself back in late 2016. But after its big drop, Duluth trades today at a trailing price-to-earnings ratio of roughly 32 and a forward P/E, based on next year's earnings estimates, of around 25. Looking at the company's track record, and the many years of expansion ahead, I believe Duluth's shares are currently underpricing the company's long-term potential.