Dick’s Sporting Goods: The Catalysts are Here – Take a Position before Analyst Day

We are posting a report by Shaun Currie, a former co-worker. Shaun’s work has been featured before and believe he is a good example of how a young analyst can improve his skills over time with a modest amount of mentoring. We encourage other young analysts to read his reports and follow his progress. He has started a research firm that you can find with this link.  Young investors should develop their own process and analytical style by exposing themselves to a multitude of investors and deciding what fits their personality and mental make up. Value investing takes a certain type of personality and mental outlook and isn’t something that everyone can succeed at. The wide variance in styles of successful value investors (Schloss, Gabelli, Tweedy Browne, Buffett, Whitman, etc.) shows that there is a place for many types of personalities.  At Investing 501 we try to encourage individuals to think for themselves, but try to focus that effort with examples and concepts we have found personally helpful.

Dick’s Sporting Goods: The Catalysts are Here – Take a Position before Analyst Day

Dick’s Sporting Goods recently presented at the Goldman Sachs (GS) retail conference, and the stock responded quite positively (up 10% since the presentation). But, with an investor day only a week away, there are plenty of catalysts to take the stock 20% higher. Catalysts Include:

  1. The new Field and Stream concept
  2. 2014 guidance is possible at the analyst day, and the company has a low bar to beat
  3. Increased guidance on store expansion makes the original 900 store goal more feasible
  4. The company is testing smaller store concepts, which has been something investors have been hoping for
  5. The company has a plan in place to reach double-digit margins
  6. The company is growing their e-commence and omni-channel platform, while increasing margins in the business at the same time
  7. The company is investing in more employees, which investors have been hoping for
  8. The company is taking share through their store-inside-a-store concepts with the major apparel companies

Most importantly, the analyst day next week should be the platform the company needs to present its plan for the future. I am encouraging investors to buy the stock before next week’s analyst day. I have a $60 price target and believe that investors can make 20% on the stock in the next six months.

Catalyst #1 – The New Field and Stream Concept

The most important catalyst for the company is the new Field and Steam concept, which is similar to a Cabelas (CAB) or Bass Pro Shop type store. This catalyst affects almost every other catalyst for the business, including store expansion, store size, and margin expansion. DKS just recently opened its first Field and Stream concept, and during the company’s recent presentation management commented that there were 3000 people lined up outside the store for the opening and that “the store’s first month performance was better than any store, of any type of concept, that the company has ever opened.” This was the biggest news from the presentation.

The store size is 35,000 square feet, which is both smaller than the average DKS store and the average Cabelas store (average size of DKS store is 50,000 sq ft and average Cabelas is 100,000 sq ft). Furthermore, management noted that the consumer does not like to shop at Dick’s for outdoor goods, so this will create more incremental sales than just store expansion (and hopefully justify smaller store concepts for Dick’s by reducing the outdoor segment of the store).

Furthermore, considering that a large percentage of Cabelas and Bass Pro Shop sales are still catalog based, physical outdoor stores are currently underpenetrated (as shown by Cabelas’ plan to increase their own store base), so the feasibility of store growth is very realistic. This outperformance and growth by the concept should help DKS sustain above-average revenue growth going forward.

Catalyst #2 – Analyst Day Could Provide 2014 Guidance

On the company’s Q2 earnings call, management lowered guidance for the rest of the year due to three main concerns:

  1. A retail macro slowdown due to a consumer shift in spending to autos and housing
  2. A slowdown in the golf category
  3. A possible slowdown in store growth

During the recent presentation, the company noted that they have seen a pickup in sales, and although they are still being conservative, they have increased confidence in the business after the recent results. Plus, this is macro-based and not company specific. DKS, as well as most of the industry, has also seen a recent pickup in golf (especially considering the company’s leverage to Taylor Made (ADDYY)). After the performance of Field and Stream, management also became more confident on store growth.

Considering analyst’s estimates for DKS 2014 earnings dropped from $3.30 to $3.10 after the Q2 call, I see the opportunity for management to beat expectations for 2014 during the upcoming analyst day. When asked about 2014 at the presentation, management noted that it will “be fairly easy to beat 2013 results next year.”

Analyst estimates are for 9% growth in revenue next year. This is basically just store expansion. Any positive comps (off an easy comparable in 2013) or e-commerce growth would allow the company to beat these revenue estimates. Additionally, the company should repurchase at least 7.5% of the outstanding stock over the next 18 months and has already called for margin expansion through its growth initiatives, so 20% EPS growth is a much more realistic expectation. A low bar has been set for the analyst day, and I expect management to beat current expectations.

Catalyst #3 – Store Expansion

At the recent conference, management did a great job laying out its store expansion strategy:

 shaun

There has been contention in the analyst community over the last couple years as to whether or not DKS will reach, or even need, 900 stores. At the same GS retail conference a few years back, management noted that if e-commerce grows faster than expected, the 900 goal target may not be feasible. I have been using an 800 store estimate over the past couple years to justify my $50 price target, but after the recent increase in guidance for stores to 1100, combined with the feasibility of growth for the Field and Stream Concept, I am increasing my store target to 900 stores, and increasing my price target to $60.

Note: The company is also testing a True Runner store (running specialty store like The Finish Line (FINL) has), but considering that it is still in test phase and that there are only two stores currently, I am leaving this concept out of my analysis on the company.

Catalyst #4 – Testing Smaller Size Concepts

Another point of contention with the analyst community has been the need for 50,000 sq ft stores. This point didn’t mean much though, as CEO Edward Stack is a controlling voter, and he believed that 50,000 sq ft was the right move. After the recent presentation, I have seen a shift in sentiment by Mr. Stack for several reasons:

  1. Management stated they have tested the 35,000 sq ft concept
  2. The Field and Stream concept will be 35,000 sq ft
  3. If Field and Stream is successful, it could justify reducing the size of the outdoor segment in the Dick’s store, thus justifying more smaller store concepts

The reduction of rent costs as a percent of sales alone would support the double-digit operating margin target, which will be one of the big growth drivers for the company over the next five years.

Note: After speaking with investor relations, the company does say if Field and Stream is successful these would consider reducing the size of the outdoor footprint in the Dick’s store, but would most likely use the space to add to growth areas, such as youth and women’s apparel. This would support the company maintaining the 50,000 sq ft store base. I will note, this makes sense considering leases are already in place on existing stores, but new stores could still be smaller size.

Catalyst #5 – Margin Expansion

Management has a goal to take operating margins from 8.5% to at least 10% over the next five years. They will do so using the following initiatives:

  1. Increasing private label and private brands to $1B in sales by 2017 (these brands have margins 6-8% higher than the products they replace).
  2. Expand sales of higher-margin products (Nike (NKE), Under Armor (UA), and The North Face (VFC)) through expansion of the store-inside-a-store concept.

The company can also increase margins by:

  1. Reducing rent costs through optimization of the real estate footprint.
  2. Driving omni-channel growth and reducing dependence on GSI Commerce (EBAY) – more on this in a bit.

Overall, the margin targets are very realistic (even conservative) over the next five years. This, along with share repurchases, will support higher EPS growth than the already above-average revenue growth.

Catalyst #6 – E-Commerce Growth and Margin Expansion

During the recent presentation, management also highlighted the goal to triple the size of their e-commerce business. E-commerce is currently 6% of sales ($350 million), so this goal would take e-commerce to $1B in sales. With this target, the company has also stated that it reduce its reliability on GSI Commerce as DKS expands the omni-channel. Reduced fees paid to GSI will support margin expansion in the e-commerce segment going forward.

Catalyst #7 – Investing in Payroll

In my recent conversations with other analysts and consumers, I noticed a trend when speaking about DKS, “they don’t have enough employees in the stores.” This is a big deal when DKS is competing against Amazon.com (AMZN) for business. DKS has to win on service to justify the real estate footprint. During the recent presentation, management noted that they will be investing in payroll. The company will also focus on premium services inside the store to promote an enhanced in-store experience. I take this as a big positive for the company, and it gives me more confidence in positive comps going forward.

Catalyst #8 – Store-Inside-a-Store Concepts Winning

The company has been growing the store-inside-a-store concept, and has been seeing very positive results. Currently, The Nike Fieldhouse Shop is in 222 stores, the Under Armor Shop is in 174 stores, and The North Face Shop is inside 91 stores (there are also 80 seasonal shops). As these concepts grow, so will margins. The company has also been pushing its shared service footwear shop (currently in 183 stores).

Valuation

Now that we have a sense of the multiple catalysts that will drive the company, let’s take a look at valuation. First, let’s look at the current valuation compared to its competition:

P/E EV/EBITDA EV/Sales
DKS 16.5x 9.0x 1.0x
BGFV 11.0x 9.0x 0.5x
HIBB 16.0x 10.0x 1.5x

We see that DKS trades in the mid-range of the industry, yet has a significantly larger market share and presence. All three of these companies have a growth platform, but DKS has significantly more company-specific catalysts (especially in the short-term). Considering store growth, margin expansion, and the opportunity with Field and Stream, combined with share repurchase activity, the company should be able to grow earnings at 20% annually, making the stock look very cheap. Considering I expect estimates to increase after the upcoming earnings call, the stock is actually only trading at 15.0x expected earnings. I am using a $60 price target based on a blend of 18x 2014 EPS and 10x 2014 EBITDA. This is 20% upside to the current price, and what’s more, I expect the company to reach this price level in the next 6 months due to the upcoming catalysts.

Market Share Opportunity

The sporting goods industry is highly fragmented, and as DKS grows its stores and brand image, there will be an opportunity to increase this share. DKS currently has 9 percent market share. If the company could increase share to 11% (half of what the total mass merchant market currently has), it would increase sales by almost 25%. Considering The top 5 sporting goods retailers and the mass merchants control only 54% of the market combined currently, there is also a big opportunity to take share from the smaller retailers.

The same holds true for the outdoor segment. Though DKS does not believe they will take share from Cabelas and Bass Pro Shop, these two companies control only 8% of the market. There is a big opportunity to take share from the mom and pop stores, as well as Wal-Mart (WMT).

Risks

Risks for the company include:

  1. Risks associated with real estate expansion – there is always the risk that the company cannot find/may not need 1100 locations (this is why I am being conservative with a 900 store target)
  2. The Field and Stream concept may not work on a larger scale
  3. NKE and UA could push their direct to the consumer platform (even though I will note, I once spoke to the CEO of UA at a conference and he noted that his company has no plans to do so)
  4. Management could choose not to give guidance at the analyst day
  5. E-commerce growth could be unsuccessful

Conclusion

DKS has many catalysts on the horizon, including next week’s analyst day. Furthermore, the Field and Stream concept could be a home run for many aspects of Dick’s business. Valuation, considering the growth potential, is attractive and below the company’s historical valuation. I am encouraging investors the buy the stock before next week’s analyst day, with a price target of $60 over the next six months.

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About Tim Heitman