The Dixie Group: The Restructuring Process Is Giving Results (NASDAQ:DXYN)

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Investment thesis

The Dixie Group (DXYN) hasn’t been through a good decade and proof of this is the price of its shares, which fell more than 95% from 2014 to 2021. Since 2014, the company has only reported positive net income in 2019 and during the current trailing twelve months. The recent sale of the commercial business segment represents a paradigm shift as the company can now focus on its more profitable residential segment.

Also, the company has focused on expansion in the faster-growing hard floor industry, introducing luxury vinyl flooring (LVF) and engineered wood products to its portfolio. If we add the efforts to reduce costs in recent years, the result is that profit margins have been increasing continuously since the end of 2019, which is helping the company to generate positive cash from operations and pay off its debt pile while reducing interest expenses steadily. Even so, positive cash from operations during all the years except 2017 has made possible a reduction in debt that has only been really effective since 2019 thanks to the recent increase in profit margins, since before this, capital expenditures and interest expenses took all the profit of the company. Recent divestitures also helped the deleveraging process.

The recent improvement in margins has caused a huge increase in the price of shares, which accumulate over 650% from the worst moments of 2020, but we have to take into account that, by then, they were trading practically at a bankruptcy price and that they are still 76.21% below the highs of 2014. For this reason, I believe it is worthwhile to carefully analyze the company’s chances of improving its long-term prospects with its remaining residential business.

A brief overview of the company

The Dixie Group is a global marketer, manufacturer, and seller of upper-end floorcovering products for residential customers through their Fabrica, Masland, Dixie Home, Calibré, and Trucor brands. The company’s products include broadloom carpet, carpet tiles, rugs, engineered wood, and luxury vinyl flooring. The company’s operations have been historically divided into two main operating segments: residential and commercial, but the company has recently divested its commercial segment in order to focus on the more profitable residential segment and, to compensate for declining revenues from weakness in the soft floorcovering market and the divestment of the commercial segment, it has launched new engineered wood and luxury vinyl flooring offerings.

The Dixie Group was founded in 1920 and currently employs over 1,400 workers. Its market cap stands at ~$71 million, which means it’s a small-cap company, and insiders own 20.55% of ownership, so the management is one of the main beneficiaries of the turnaround.

The Dixie Group website

thedixiegroup.com

The company doesn’t pay a dividend and is currently deleveraging its balance sheet after an acquisition spree in 2010-2014, which should help to expand the possibilities of expansion through new acquisitions as the debt, as well as interest expenses, continues to decrease. Also, it reduced its shares outstanding by 4.04% since November 2018 as it announced a share repurchase program of up to $5.9 million in October 2019, which was completed in March 2020.

Dixie Group price chart
Data by YCharts

Currently, shares are trading at $4.38, which represents a 76.21% decline from mid-term highs of $18.41 on April 2, 2014. Even so, we must take into account that the current drop in the share price reflects a potential difficulty for the company to generate cash during the coming quarters due to the increase in the cost of raw materials and increased transportation costs, as well as labor shortages, due to its relatively narrow margins. In order to understand the current situation, it is very important to make a review of the acquisitions and subsequent divestitures that have brought the company to its current situation.

Acquisitions and divestitures

During the first half of the last decade, in the period 2010-2014, the company made extensive use of debt to expand its business through acquisitions, which initially helped it to expand revenues. Here is a summary of the company’s acquisitions during that period:

In November 2012, the company acquired a carpet dyeing facility in Calhoun, Georgia, for $6.6 million. During the same month, the company acquired the specialized wool rug tufting equipment and related business from Crown Manufacturing, Inc. for $2.6 million. The following year, in June 2013, the company acquired Robertex, a manufacturer of carpets, rugs, flooring, and more, for $7.3 million.

In March 2014, the company acquired Atlas Carpet Mills, Inc., a manufacturer of commercial broadloom and tile carpeting, for $18.76 million. Later in the same year, in September 2014, the company acquired Burtco Enterprises, Inc., a provider of soft floorcovering and other related carpet products serving the hospitality industry, for $2.5 million.

Sales increased as a result of all these acquisitions by 58.60% from 2012 to 2015, but profit margins deteriorated at the same time due to weakness in the soft floorcovering industry, which created serious difficulties in generating cash for the company and, in October 2019, the company sold its Susan Street facility to CenterPoint Properties Trust for $37.2 million. Finally, in September 2021, the company sold AtlasMasland, which operated in the company’s commercial business, to Mannington Mills, Inc. for $27.5 million in order to exit the commercial business and focus on the residential business by retaining two manufacturing facilities of the segment in Atmore and Saraland and expanding residential production capacity in them. The commercial segment reported sales of $103 million in 2019 or 27.57% of total sales. Since then, the company has focused on hard surface product launches as they were gaining popularity in the industry.

Net sales are still weak

The company’s sales have suffered declines since 2015 due to weakness in the soft floorcovering after a few years of prosperity due to acquisitions, although most of the drop has taken place during the coronavirus pandemic in 2020. In this sense, sales fell a total of 12.78% from 2015 to 2019, and an additional 15.66% in 2020, so the fall is not so dramatic after all.

The Dixie Group net sales

The Dixie Group net sales (10-K filings)

After the coronavirus pandemic impact on sales, during the first quarter of 2021, net sales increased by 7.10% year over year (but declined by 2.60% compared to the same quarter of 2019), so the year 2021 began in a situation similar to that of 2019 in terms of sales, although there was still work to be done as 2019 wasn’t a good year either. During the second quarter of 2021, net sales increased by 208.91% year over year (and by 4.42% compared to the same quarter of 2021), and finally, during the third quarter of 2021, net sales increased by 3.93% year over year (but again, this represented a decline of 6.45% compared to the same quarter of 2019). This is caused by the sale of the commercial segment as residential sales actually increased by 27.50%.

Dixie group PS ratio
Data by YCharts

The company’s P/S ratio currently stands at 0.158x, which means the company generates $6.33 in sales for each dollar of market cap, annually. As we can see, the current P/S ratio no longer reflects the panic it did in 2019, 2020, and part of 2021, but it is still a long way from 2014 levels and is offering enormous potential to investors who have enough patience to wait for the turnaround to materialize as sales of $6.33 per share annually is a very large amount if we take into account the profit margins reported during the last few quarters.

Margins are expanding as the company sold the commercial business

The company has posted negative net income in 2014, 2015, 2016, 2017, and 2018. But finally, in 2019, net income was positive at $15.3 million, and although the coronavirus pandemic crisis caused again a negative net income of $9.2 million in 2020, the current trailing twelve months’ net income is again positive at $7.4 million.

In this regard, the evolution of the company in recent quarters has revolved around profit margins. The company’s gross profit margins and EBITDA margins recovered after suffering a continuous and accelerated deterioration in 2018 and 2019 due to weakness in the soft floorcovering industry, restructuring costs, and inventory write-downs, and both are currently at levels close to those achieved in 2014.

Dixie group gross profit margin and EBTIDA margin
Data by YCharts

Furthermore, gross profit margins during the last quarter were 27.92%, which is significantly higher than the trailing twelve months of 25.86%, setting new highs for the last decade. EBITDA margins of 9.62% during the last quarter were also significantly higher than results of recent years. This has been accomplished by successfully increasing the price of products about five times in 2021 in order to pass on the increased costs of raw materials, labor, and transport to customers while using older inventories, but increasing cost of raw materials, labor shortages, and higher transportation costs pose new challenges in the quarters to come and margins are expected to stabilize at a lower level in the short term as the management recognized in the last earnings call conference.

The management has carried out a cost restructuring program during the past few years in order to improve profit margins and they actually began to improve before the coronavirus pandemic crisis. As we can see in the graph below, the company started to generate positive cash from operations in 2019, enough even to cover interest expenses widely.

DXNY cash from operations and total interest expense
Data by YCharts

The company failed to cover interest expenses with cash from operations in 2017 and 2018, causing a huge share price drop of ~80% since 2014, causing panic among investors. Although the company is currently facing a drop of 76.21% in the price of shares since 2014, the picture is completely different from 2017 and 2018. Trailing twelve months’ cash from operations is currently negative at -$0.5 million, but the company increased inventories by $15.3 million during the same period while accounts payable increased by $12.2 million and receivables by $9.1 million, so the company should be able to continue paying some debt in the coming quarters as the price increases fully take effect.

Debt is decreasing very fast

As a consequence of the acquisition spree carried out in the first half of the past decade, the company accumulated a sizeable debt pile, which did not begin to be successfully paid down until the end of 2019 when profit margins began to pick up.

DXNY total long term debt and cash & equivalents
Data by YCharts

The company has decreased long-term from $78.2 million during the third quarter of 2020 to $60.4 million during the third quarter of 2021, a reduction that was boosted by the sale of the commercial business. The current long-term debt of $60.42 million is much lower than long-term debt of over $120 million during 2017.

DXNY Total interest expense
Data by YCharts

The recent reduction of long-term debt has decreased interest expenses from $1.6 million during the third quarter of 2020 to $1.6 million during the third quarter of 2021, which is freeing up more cash each quarter.

Risks worth mentioning

First of all, I would like to highlight that The Dixie Group is very small as it is a micro-cap company. The company competes with much larger players like Mohawk Industries (MHK), which has a large presence in the hard floorcovering market that Dixie is trying to access. This could significantly hinder the company’s ability to maintain competitiveness in the industry and gain market share.

We should also keep in mind that recent increases in the cost of raw materials, labor, and transportation pose a risk to the company’s ability to remain profitable. In this sense, the management has divested the less profitable commercial business segment, increased the price of its products about 5 times in recent quarters and is focusing on launching products with greater added value, but we must bear in mind that the company’s margin of maneuver, if it fails to generate positive cash despite these initiatives, is quite limited.

The company’s annual interest expenses of ~$5 million represent a risk for the company because if it fails to generate enough cash to cover it, it will continue to need additional debt to meet the payments as cash on hand is very low at $1.25 million. The positive point is that trailing twelve months’ interest expenses are expected to decline sharply as a consequence of the recent decline in long-term debt. Considering the $1.2 million, actual current interest expenses should be around $4.8 million per year.

Conclusion

I believe that the restructuring process of The Dixie Group is at a fairly advanced stage. The company has finally divested the commercial business, which was its smallest segment, and is now focusing on the residential business, adding higher-end hard floorcovering products, which is a market growing faster than the soft floorcovering market that had been running out of steam in recent years. Gross profit margin and EBITDA margin have shown dramatic improvements since 2019, and the residential business is growing at a fast pace, which is allowing the company to achieve a positive net income after several years of agony.

The company has cut its long-term debt by more than half after the acquisition spree ended in 2014, and this is greatly reducing interest expense while expanding the margin to expand its residential business segment with new acquisitions once debt becomes more manageable. Still, investors’ pessimism is leaving a P/S ratio of 0.158x, much lower than the P/S ratio of ~0.50x experienced in 2014 despite recent margin expansion, and I believe this is caused by uncertainties related to the recent increase of the cost of raw materials, labor, and transportation, three issues for which management is responding with price increases for their products.

For these reasons, I believe it is a good time to initiate a position in The Dixie Group but, due to the recent volatility in the company’s profitability coupled with current inflationary pressures, it would be a good idea to save a bullet in order to average down in case the company offers us the opportunity to acquire shares at a lower price in the future.



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