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Turnaround Seen for
Duluth Holdings, rated a “Buy”

Despite all of the operational missteps, Duluth Holdings remains sturdy and purchase is now recommended, suggests veteran turnaround investor, George Putnam, III, editor of The Turnaround Letter, www.TurnaroundLetter.com.

Duluth Holdings (DLTH) is a specialty apparel company that sells rugged work-oriented outdoor clothing through a colorful marketing approach. Founded in 1989 by three construction workers in Duluth, Minnesota, who created an innovative canvas tool organizer, the company initially sold its products by mail-order catalog. In 2000, it merged into a company owed by the current chairman. and completed an initial public offering in November 2015. Through the Duluth Trading brand, the company has grown into an omni-commerce retailer with 61 stores across the United States.

Following its IPO, the company's sales increased rapidly, earning a reputation among investors as a rare, fast-growing apparel concept. By late-2016, optimism about its long-term prospects drove its shares to over $37, more than triple its $12 IPO price. Despite subsequent concerns about its profitability, which led to a sharp share price decline, renewed investor confidence pushed the shares back near record-highs by mid-2018.

However, the focus on revenues caught up to the company. Its aggressive store expansion, adding 52 stores in four years to its 9-store base at its IPO, overwhelmed its infrastructure and management capabilities. Compounding its problems, the company's poor retail site selection led to weak store productivity, which prompted even more marketing spending, further weighing on profits These blunders produced an unrelenting cadence of disappointing results. Operating income for the current fiscal year will likely be below its pre-IPO level. Investors also worry about its lease obligations, which may impede its ability to close stores. Growth investors have lost confidence in Duluth Holdings shares, which now trade 25% below the IPO price.

Analysis:

Duluth's problems are almost entirely self-inflicted and appear fixable. Most important, the company is acknowledging its problems. The founder/chairman (who holds a controlling stake and recently added to his position) has publicly stated that the company will meaningfully slow its new-store expansion, instead emphasizing growth by improving the productivity of its existing stores and its catalog/ecommerce channels, as well as by introducing new products.

Profit margin expansion has returned to a top priority. The CEO behind the failed strategy has departed for another company, allowing Duluth to find a new chief executive who is better suited to the new priorities.

The company is implementing a major upgrade to its infrastructure, including a newly-completed order/inventory management system which should curtail margin-eroding markdowns. An upgrade to its Belleville distribution center should improve its distribution efficiency. In 2020, the company's new point-of-sale system and customer data analysis system should be on-line.

Despite all of the operational missteps, the company remains sturdy. The unique and high-quality brand is strong, particularly in the core upper Midwest markets. Even with the low-productivity stores, retail sales per square foot is a healthy $450. Duluth continues to generate GAAP net profits. The flat operating income mostly reflects the rising burden of non-cash depreciation such that EBITDA for this year should be 35% higher than four years ago. The company's balance sheet is modestly levered at 2x EBITDA, which will likely decline to about 1.2x when it pays down its line of credit with holiday sales.

The company’s shares trade at a low valuation of 5.3x our expected FY2020 EBITDA. While the turnaround will likely take at least a year or two, during which time the shares could be volatile. Duluth is taking the necessary steps to return to a more profitable and highly-valued business that shareholders should find quite rewarding. We recommend the purchase of shares of Duluth Holdings (DLTH) with a $15 price target.”

Editor’s Note: Published for over 30 years by George Putnam III, The Turnaround Letter, a monthly newsletter, 1 year, $740, focuses on longer-term turnarounds, usually with a 2-3 year horizons. Stocks on the Recommended List, have produced an annualized rate of return of 9.4% over the past 20 years, compared to the 6.4% annualized rate of the S&P500 Index through January 31, 2020, as compiled by The Hulbert Financial Digest. For more information on the one year Membership visit www.TurnaroundLetter.com.

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