Friday, 20 November 2015

Dick's Sporting Goods: after the Q3 shocker, an opportunity to get back in?

I have written intermittently on the does-what-it-says-on-the-tin retailer Dick's Sporting Goods over the past 18 months most recently around a year ago (link here) where I concluded the share was in a broadly US$40-50/52 range.  18 odd months ago I was initially a buyer of the stock near the bottom of this range and that worked kind of ok and I realised profits (a bit early as it happened) in the early Spring period this year.

But as the share price chart above shows in the last few days the stock has crumbled below that US$40 level.  So what is going on and has an opportunity presented itself?  As Seeking Alpha noted the company's forward guidance from its Q3 numbers was not the hottest and despite gross margins and e-commerce sales rising I also note the big proportional inventories increase: 

Dick's Sporting Goods (NYSE:DKS) reports same-store sales rose 0.4% in Q3.
The comp for Dick's chain increased 0.7%, while Golf Galaxy decreased 2.9%.
E-commerce penetration +70 bps to 8% of total sales.
Gross margin rate grew 10 bps to 29.7%.
SG&A expense rate increased 60 bps to 24%.
Inventory +13.1% Y/Y to $1.997B.
Store count +54 Y/Y to 744.
Q4 Guidance: Same-store sales: -2% to +1%; Diluted EPS: $1.10 to $1.25; Shares outstanding: 115M.
FY2015 Guidance: Same-store sales: ~flat to +1%; Diluted EPS: $2.85 to $3; Shares outstanding: 117M; Capex: $245M.

My previous reports on Dick's Sporting Goods also made reference to the struggling golf business...but this time something is different as noted by this comment in the conference call: 

'We’re cautiously optimistic about golf. As we’ve said, golf actually comped positively on a consolidated basis in the third quarter. Our margin rates, which we had indicated before, expanded approximately 200 basis points'

So what was the problem?  Well the core of it was how the weather had impacted hunting and related product demand: 

'the warmer weather that has extended all the way into November is causing inventory issues that will require a very promotional holiday...The Company is working with its vendors to reduce its exposure to slow-selling merchandise by returning product, canceling orders and securing markdown allowances'

With the downgrade implied in Q4 guidance around 18% (to the mid-point of the new guidance) no wonder the shares slipped over 15%...

The tone of the conference call was suitably defensive highlighting the tactical weather issues but also the recent strategic need for margin-diluting investment in the business.  Nevertheless the growth of e-commerce continues and - of course - the company remains the place to go for the hunting/fishing fraternity in particular...and with the c. 25% of sales from golf lapping easy comparisons another pressure from the business has been removed.  Have a look at my original report back 18 months odd ago for a graphic-heavy introduction to the company.  

The trouble is the company has blotted its copybook.  Using the guidance given then operating profitability will still be over US$500m in FY15...but clearly variability for FY16 is potentially.  Nevertheless at a current EV of US$4.6bn and basically no net debt FY16 profitability would have to fall by c. 15% to push the EV/ebit ratio back above x10.  With equivalent of 6% of the company's market cap still available to buy back (and the aforementioned balance sheet strength gives clear extra flexibility) opportunity feels reasonable to me.  

In short even a pessimistic outlook still suggests a return to the US$40s...and just as established before a fuller recovery (and some more normal weather conditions) opens up the scope for another return to US$50.  Dick's Sporting Goods is a buy here in my view.  

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