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Has Duluth Holdings' Growth Just Begun?

By Andy Gould - Nov 30, 2017 at 8:16PM

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This online retailer of rugged workwear and gear is in the early stages of building a national brick-and-mortar presence.

Duluth Holdings (DLTH -3.03%) is the company behind the Duluth Trading brand of workwear and casual clothing. Having opened just 29 retail stores so far to complement its existing online business, the company is still in the early innings of a significant national expansion.

But investors have been skeptical of most retail stocks not named Amazon lately -- and Duluth is no exception. In spite of back-to-back strong earnings reports, the stock is down around 26% year to date as of this writing. Here's why I believe Duluth looks set to grow robustly for years to come.

DLTH Chart

DLTH data by YCharts.

Duluth's online game is already impressive

This isn't a dying mall-based retailer that's trying to regain relevancy with e-commerce. The company's early growth was fueled by online sales, and e-commerce accounted for nearly 60% of Duluth's sales in the most recent quarter. While its direct (online and catalog) sales are growing more slowly these days, they provide Duluth a solid, profitable base to build on as it adds retail locations.

The exterior of a Duluth Trading store

Image source: Duluth Holdings. 

Aggressive retail expansion ahead

Duluth opened its first physical store in 2010, but the company is still just getting started as a brick-and-mortar retailer. Using customer data from its online and catalog sales, the company has now identified 100 locations around the country that have the right combination of population density and Duluth customer demographics.

Last year, the company began accelerating its pace of expansion, ending 2016 with 16 stores. The company this week announced the opening of its 30th and 31st stores, in Wisconsin and Michigan, and plans another 15 stores in 2018. That would put it nearly halfway to its 100-store goal by the end of 2018.

Additionally, while the company's first stores were in smaller markets like its hometown of Mt. Horeb, Wisconsin, many of its newer stores are in and around major U.S. cities like Chicago and Washington, D.C., thereby exposing the Duluth brand to a much larger group of potential customers. And while the company currently has zero stores in its top three states for direct sales -- California, Texas, and New York -- it is planning openings in Texas and New York in 2018, followed by its first California store in 2019.

The good news for investors is that these new stores are helping attract plenty of first-time customers. According to the company, 25% of new Duluth customers in 2017 made their first purchase at a retail location. Even better, company data shows that Duluth's retail operations don't cannibalize direct sales -- they increase them.

Differentiated products + distribution control = healthy margins

From less-restrictive men's underwear to women's tank tops that don't ride up, Duluth creates premium products that solve real-world issues for its customers. This product differentiation is the foundation for the quirky, entertaining television ads the company has become known for.

Duluth also happens to have total control of its distribution -- meaning you can only order directly from the company or purchase from one of its stores. That keeps Duluth's loyal customer base coming back to buy at full profit margins instead of looking for lower prices on Amazon or other websites. In fact, even though the company has been seeing some margin pressure on the e-commerce side due to free-shipping expectations, the company's overall gross margin has been holding steady in the 56% to 57% range since 2013.

A surging women's business

Despite being known largely for its men's clothing, Duluth's women's business has been on a tear. From 2012 through 2016, women's sales increased at a 45% compound annual growth rate, growing even faster than its men's sales.

The women's business made up 21% of Duluth's total sales last year, but that number should only get larger as the company expands its women's offerings and increases the proportion of its marketing spend aimed at women. For a company that once exclusively targeted tradesmen, the women's market should help deliver plenty of incremental growth in the years ahead.

This ride looks far from over

The factors above have helped Duluth increase sales at a 32% compound annual growth rate from 2013 to 2016. Over the same period, adjusted EBITDA and net income (on a pro forma basis) grew at similar rates.

Though growth will naturally slow as Duluth gets larger, the company's most recent guidance implies 2017 top-line growth of 22.3%. That's above its long-term target of 20% annual sales growth.

On the earnings side, Duluth is guiding for 2017 adjusted EBITDA growth of 17.2% -- below the company's long-term target of 25%. Net income and adjusted EBITDA growth will probably remain more moderate over the next few years as Duluth invests heavily to build up its store base. But so long as the company keeps satisfying customers with innovative products and sticks to its road map for national expansion, Duluth investors should have many years of substantial revenue and profit growth to look forward to.

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