INTRINSIC VALUE ASSESSMENT OF
DICK’S SPORTING GOODS INC. (DKS)
APRIL 30, 2018 This article was written with David J. Flood from The Investor’s Podcast
IntroductionDick’sSportingGoodsInc.isanAmericanbasedomnichannelsportsgoodsretailerwhoseoperationsinvolvethesaleofsportsequipment,apparel,footwear,andaccessories.Thefirm’smarketcapcurrentlystandsataround$3.31Billionanditsrevenuesandfreecashflowsforthepreviousfinancialyearwerearound$8.6Billionand$0.27Billionrespectively.Thecompany’scommonstockhasfluctuatedbetweenahighof$52andalowof$24overthepast52weeksandcurrentlystandsataround$34.IsDick’sundervaluedatthecurrentprice?
The Intrinsic Value of Dick’s Sporting Goods, Inc.TodeterminetheintrinsicvalueofDick’s,we’llbeginbylookingatthecompany’shistoryoffreecashflow.Acompany’sfreecashflowisthetrueearningswhichmanagementcaneitherreinvestforgrowthordistributebacktoshareholdersintheformofdividendsandsharebuybacks.BelowisachartofDick’sfreecashflowforthepasttenyears.
Asonecansee,thecompany’sfreecashflowhasbeenlumpyoverthepastdecadewhichisacommonfeatureforcyclicalcompanieswhosebusinessistiedtothefluctuationspresentinthebusinesscycle.TodetermineDick’sintrinsicvalue,anestimatemustbemadeofitspotentialfuturefreecashflows.Tobuildthisestimate,thereisanarrayofpotentialoutcomesforfuturefreecashflowsinthegraphbelow.
INTRINSIC VALUE ASSESSMENT OF
DICK’S SPORTING GOODS INC. (DKS)
Whenexaminingthearrayoflinesmovingintothefuture,eachonerepresentsacertainprobabilityofoccurrence.Theupper-boundlinerepresentsa5%growthratewhichisbasedonthemarket’scurrentexpectationsforthecompanyisthenextfiveyears.Thisgrowthratehasbeenassigneda30%probabilityofoccurrencetoaccountforthethreatofcompetitivepressurefromthefirm’speersandtheincreasinglikelihoodofarecessionaryenvironmentemerginginthenexttenyears.
Themiddlegrowthlinerepresentsa0%growthratewhichisbasedonthefirm’shistoricalfreecashflowgrowthfortheprevioustenyears.GiventhecompetitivepressureDick’sisfacingandsignsofweakeningconsumerdemand,thisscenariobeenassigneda60%probabilityofoccurrence.
Thelowerboundlinerepresentsa-5%rateinfreecashflowgrowthandassumesthatconsumerdemandfurtherweakensandthatcompetitivepressurescontinuetomount.Thisgrowthratehasbeenassigneda10%probabilityofoccurrence.
Assumingthesepotentialoutcomesandcorrespondingcashflowsareaccuratelyrepresented,Dick’smightbepricedclosetoa7%annualreturnifthecompanycanbepurchasedattoday’sprice.We’llnowlookatanothervaluationmetrictoseeifitcorrespondstothisestimate.
BasedonDick’scurrent‘forwardrateofreturn,’ametricwhichusesnormalizedfreecashflowplusrealgrowthandinflation,thecompanyiscurrentlyyielding13.91%.Thisisinlinewiththefirm’s10-yearhistoricalmedianof13.90%,suggestingthatthecompanymaybetradingatafairvaluerelativetoitshistoricalcomparison.Finally,we’lllookatDick’snormalizedfreecashflowyield,ametricwhichassumeszerogrowthandsimplymeasuresthefirm’saveragefreecashflowforthelasttenyearsagainstitscurrentmarketprice.Atthecurrentmarketprice,Dick’shasanormalizedfreecashflowof5.92%.
Takingallthesepointsintoconsideration,itseemsreasonabletoassumethatDick’siscurrentlytradingaroundfairvalue.Furthermore,thecompanymayreturnaround7%atthecurrentpriceiftheestimatedfreecashflowsareachieved.Now,let’sdiscusshowandwhytheseestimatedfreecashflowscouldbeachieved.
INTRINSIC VALUE ASSESSMENT OF
DICK’S SPORTING GOODS INC. (DKS)
The Competitive Advantage of Dick’s Sporting Goods, Inc.Dick’sSportingGoodsInc.hasvariouscompetitiveadvantagesoutlinedbelow.
• NicheAttribute.Dick’sdifferentiatesitselffrommanyofitscompetitorsbyoptingtostockhigher-endspecialtyproductsandmerchandisewhichtypicallycarryhighermarginsthanmidandlow-tierproducts.Thisallowsthecompanytooutperformtheindustryonseveralkeymetricsoutlinedinthetablebelow.
• Omni-channelModel.Dick’shasgrowntobecomethelargestomnichannelfull-linesportsretailerintheU.S.Byemployingthismodel,thefirmisbetterequippedtoreachitstargetcustomersandeffectivelymarketitsproducts.Overthepastyear,thefirmhasmoveditse-commercebusinessin-housewithonlinesalesgrowing16%YOYandnowaccountingforover10%ofnetsales.Bycombiningthefirm’sestablishedbricks-and-mortarbusinesswithitse-commerceplatformandintangibleassetssuchasitsdatabase,Dick’spossessesthecompetitiveadvantagesnecessarytogrowitsmarketshare.
Figure1:Source,Dick'sWebsite
• IntangibleAssets.Throughstrategicacquisitions,Dick’shasbuiltupadatabasecontainingdataonthesportsparticipationofseveralmillionindividualsacrosstheyouthdemographic.Theseacquisitionsincludetheregistrationcompany,BlueSombrero,thegoverningbodysupportsystem
INTRINSIC VALUE ASSESSMENT OF
DICK’S SPORTING GOODS INC. (DKS)
Affinity,andGamechanger(aleadingconsumerappwhichlogsscoringandstatistics).Bypartneringwithnumeroussportsgoverningbodies,Dick’scontinuestobuildthisdatabasewhichallowsittotailoritsmarketinginanincreasinglyeffectivemanner.ThisisapowerfulcompetitiveadvantageforDick’sasneitherAmazonnorTargetpossessessucharichdatabaseofinformation.
Dick’s Sporting Goods Inc.’s RisksNowthatDick’scompetitiveadvantageshavebeenconsidered,let’slookatsomeoftheriskfactorsthatcouldimpairmyassumptionsofinvestmentreturn.
• Dick’siscurrentlyfacingincreasingcompetitivepressureascompaniessuchasNike,Adidas,andUnderArmourareoptingtomovetoAmazonortoselltheirproductsdirectlytotheconsumerthroughtheirownstoresandwebsites.Atpresent,Dick’slargesttwovendors,NikeandUnderArmour,accountforabout20%and10%ofmerchandisesalesrespectively.WithNikeandAdidasaimingtoachieve30%and40%respectivelyregardingdirect-to-consumersalesasaproportionofrevenuegrowthby2020,Dick’smayfacetheriskofobsolescenceifitcannotadapttothesechanges.
• AkeydriverforDick’sbusinessisyouthparticipationinsports,butthecurrenttrendsdonotappeartobemovinginthecompany’sfavor.ArecentstudybytheAspenInstituteshowsadeclineinregularparticipationinbothindividualandteamsportsforchildrenbetweentheagesof6and12intheUnitedStates.
Figure2:Source,aspenprojectplay.
• Dick’shasrecentlylaunchedapricematchingprogramwithmanyofitscompetitorsincludingAmazon,Target,FootLocker,andKohl’s.Thecompanyhasstatedthatitwillmatchanyqualifyingretailer’sin-storeoronlinepriceonidenticalitemswithcustomersgiventheoptionofwheretheywanttopricematch,beitonlineorinstore.TheimplementationofpricematchingandtheassociateddiscountingofproductsisariskyapproachforDick’sasitreliesonthecompanybeingabletomakeupforlossesthroughweakermarginsbygainsmadefromincrementalsalesgrowth.Thereisnoguaranteethatthisstrategywillbesuccessful,anditmayimpairperceptionofthefirm’sbrandasaspecialtyretailer.
INTRINSIC VALUE ASSESSMENT OF
DICK’S SPORTING GOODS INC. (DKS)
Opportunity CostsWheneveraninvestmentisconsidered,onemustcompareittoanyalternativestoweighuptheopportunitycost.Atpresent,10-yeartreasuriesareyielding2.96%.Ifwetakeinflationintoaccount,therealreturnislikelytobecloserto1%.TheS&P500IndexiscurrentlytradingataShillerP/Eof31.5whichis86.4%higherthanthehistoricalmeanof16.8.Assumingreversiontothemeanoccurs,theimpliedfutureannualreturnislikelytobe-2.5%.Dick’s,therefore,appearstoofferamuchbetterreturnforinvestorsatpresent,butotherindividualstocksmaybefoundwhichofferasimilarreturnrelativetotheriskprofile.
Macro Factors Investorsmustconsidermacroeconomicfactorsthatmayimpacteconomicandmarketperformanceasthiscouldinfluenceinvestmentreturns.
Atpresent,theS&PispricedataShillerP/Eof31.5.Thisis86.4%higherthanthehistoricalaverageof16.8suggestingmarketsareatelevatedlevels.U.S.unemploymentfiguresareata30-yearlowsuggestingthatthecurrentbusinesscycleisnearingitspeak.U.S.privatedebt/GDPcurrentlystandsat199.6%andisatitshighestpointsince2009whenthelastfinancialcrisispromptedprivatesectordeleveraging.
Summary Dick’sSportingGoodsInc.iscurrentlyfacinganumberofchallengeswhichdonotappeartobeabating.ItisfacingcompetitivepressurefromplayerssuchasAmazonandWal-Martwhoselow-costmodelisforcingDick’stodiscountitsproductsinanattempttoretainmarketshare.Despitethefirm’spricematchingprogram,FY2017resultsshowsame-storesalesdecliningbynearly1%.Lookingatthecompany’sperformanceoveralongerperiod,marginshavebeenonadownwardtrendsince2013withagrossmargindeclinefrom31.5%in2013to29%in2018,andanoperatingmargindeclinefrom9%in2013to5.6%in2018.
Thefirmisalsofacingtheproblemofmajorbrandschoosingtoselltheirproductsdirecttoconsumersviatheirownstoresandwebsites.Dick’sisoptingtofocusmoreonitsownprivatelabelbrandsinanattempttooffsetthis,butthereisnoguaranteethatthiswillbeawinningstrategy.
ConsideringhowDick’shasperformedinpreviousrecessionaryenvironments,investorsshouldbeundernoillusionthatthefirmwillnotbeadverselyaffectedshouldaneconomicdownturnmaterialize.Thecompanyis,however,inastrongfinancialpositionwithadebt/equityratioof0.03andanAltmanZ-Scoreof4.22suggestingthatthecompanyishighlyunlikelytobeatriskofbankruptcyinthecomingyears.
INTRINSIC VALUE ASSESSMENT OF
DICK’S SPORTING GOODS INC. (DKS)
Thereare,however,somefactorswhichmayworkinfavorofDick’s.Overthepastfewyears,anumberofthefirm’scompetitorsincludingSportsAuthority,VestisRetailGroup,andSportChalethavegoneoutofbusiness.Notonlyhasthisreducedcompetitionbutithasresultedmorethanclearanceinventoryenteringthemarketwhichhasdrivenupsupply.Assumingdemanddoesnotweaken,oncetheexcesssupplyisworkedthrough,Dick’smayseesalesbegintopickup.Dick’somnichannelstrategyisalsoshowingsomepositivesignsofe-commercepenetrationapproaching20%comparedto6.8%forTargetand1.5%forWal-Mart.
WithregardstoShareholderfriendliness,Dick’shasgrownitsdividendpaymentsonanannualizedbasisby5.26%since2012.Withinthatperiod,thefrimhasalsoimplementedsharebuybackprogramswhichhavereducedthesharecountbyanannualizedrateof2.54%
Insummary,Dick’sSportingGoodsInc.isfacinganumberofheadwindsincludingrisingcompetitivepressure,changingconsumertrends,andtheincreasinglikelihoodofarecessionaryenvironmentemerging.Basedontheconservativeassumptionsusedinthefreecashflowanalysis,Dick’smayreturnaround7%atthecurrentmarketprice,buttheauthoradvisesinvestorstocarefullyconsidertherisksbeforeconsideringaninvestment.
Disclaimer:Theauthordoesnotholdownershipinanyofthecompaniesmentionedatthetimeofwritingthisarticle.
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