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Among the retailers competing for market share within the sporting goods industry, Dick's Sporting Goods (NYSE:DKS) continues to impress shareholders. Its revenue and profit margins have displayed excellent growth on a year over year basis and looking ahead management anticipates revenue to increase in 2013 by an additional 3% from 2012. Overall, DKS is operating at an optimum level with enough capital adequacy to permit the expansion necessary to address the industry's needs, yet is still capable of maximizing shareholders' wealth. This article starts with my investment thesis, followed by a brief overview of DKS's business strategy, and its valuation in the market. Then the primary focus of this article will be directed towards DKS's Field & Stream specialty stores. I will discuss management intentions and relevant concerns investors should be aware of.

Investment Thesis

My thesis for initiating a long position in DKS is simply based on expected growth, and specifically, the potential value that can be added through the expansion of its new retail and specialty stores. Over the past 10 years, the expansion of DKS's geographical footprint has greatly enhanced its position as a major retailer within the sporting goods industry. Additionally, the increases in the breadth of DKS's product line combined with the customer loyalty established through its specialty line of goods will provide DKS with a competitive advantage that can be sustained. In 2002, DKS only operated 141 stores nationwide.

By the end of 2012, this number was 518, which equates to an annualized growth rate of approximately 13.5%. This is implying that on average DKS increases the number of stores it operates by 13.5% each year. Broadly speaking, many investors seem to perceive DKS as a mature company based on its past success and current market share within the industry. While I will not disagree, it's important that investors do not undermine its growth potential by scrutinizing the attributes typically associated with a company in its mature stage. Because DKS expects growth for the next few several years is substantially higher than the average company in its mature stage. For just FY 2013, DKS management has budgeted expenditures to accommodate the construction of 40 new stores across the nation, which would result in a total of 558 stores by the end of the year. The addition of new stores is intended to aid in effectively positioning its products in regions with growing local economies and to maximize the potential benefits within the breadth of its product line by catering to the needs of niche markets through its new specialty stores.

Company Background

In 1948, DKS was founded and incorporated in New York under the name "Dick's Clothing and Sporting Goods." The name stuck for quite a bit of time. It was not until November 1997 where DKS was reincorporated as a Delaware corporation and changed its names to Dick's Sporting Goods. Today, DKS stands at the top of its industry as a major player in the market for sporting goods.

The competitive nature of the retail industry forces DKS to actively fight for its market share. According to DKS's 10-K, here are the seven key elements that enable it to maintain its strong position within the industry:

  1. Authentic Sporting Goods Retailer
  2. Store Base Expansion and Improvements
  3. Brand Partnerships
  4. Omni-channel Development
  5. Private Brands
  6. Retail Concept Development
  7. Strategic Marketing

The two main elements that this article will focus on are the retail concept development and its private brand labels. Within the retail concept development element, DKS focuses on expanding its business and developing customer loyalty through the use of specialty stores. This element is a unique part of DKS's corporate strategy because it allows DKS to address the specialized needs for a select group of its pre-existing customers and it also serves as utility for adding value to the company. Value in the form of real earnings as well as intangible value reflected through increases in goodwill on the balance sheet. Currently, DKS's main specialty store is Golf Galaxy. Golf Galaxy was founded in 1948 and operated under DKS as a specialty retailer for golf equipment and clothing. It's important to note the potential revenue to be generated from these stores is quite significant. The general attributes of the specialized nature incorporated within stores such as Galaxy Golf gains popularity, but the real value added is the brand loyalty generated from correctly addressing the customer needs. Shown below, you will see there are currently 81 Golf Galaxy stores nationwide. As previously mentioned and shown below, DKS currently has 518 stores, which implies the Golf Galaxy specialty stores comprise about 13% of its total retail stores. Golf Galaxy is DKS's main specialty store at the moment, but DKS's management plans to open the first Field & Stream specialty store beginning this fall.


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Valuation

Currently, DKS is trading in the market for right around $52 per share. Its market capitalization is roughly $6.43 billion, which implies there's nearly 123 million shares outstanding. In terms of ownership, institutional investors own nearly 80% of its common shares outstanding.


(Click to enlarge)

Looking below at DKS's EV/EBITDA multiple, you will see it's favorably low and that it's remained relatively the same concentrated around 10x for the past two years. Also, you will notice DKS's forward price-to-earnings growth (PEG) ratio is favorable right at 1.0, which suggests DKS is evenly priced as of now. The combination of a PEG ratio of less than 1.0 and a price to free cash flow per share (P/FCF) multiple of less than 15 would indicate the stock is undervalued. However, as we saw its PEG ratio was fairly reasonable and its P/FCF is nowhere close to being below 15.

DKS EV / EBITDA TTM Chart
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DKS EV / EBITDA TTM data by YCharts

Above you will see, DKS's P/E ratio is nearly 22x. While normally this would be considered steep, it's not out of the ordinary for retailers such as DKS to exhibit an above average P/E ratio. Additionally, its six month forward P/E is 18.29x, which is highly favorable when taking into account its current P/E ratio. In addition, analysts' estimates are also favorable. Seven analysts that cover DKS have a six-month median price target of $59, which implies an expected upside of nearly 12% from its current value. Overall, I feel DKS trades in a semi-strong efficient market where its price in the market tends to often reflect its fair value.

Face-to-Face Competition or Bank on Brand Loyalty?

In particular, the DKS Field & Stream product line is a lucrative revenue segment with large potential. In many industries, it's common to witness higher profit margins source from a retailer's medium to lower priced goods as opposed to premium substitute goods that retail for a higher price. There are several ways that can make this possible, however the most common method is by utilizing ownership privileges. And this is exactly what DKS is doing. Just as DKS utilized the benefits of owning Galaxy Golf, DKS is expanding its existing Field & Stream product line to the fullest extent possible. It's clear management is attempting to increase the aggregate amount of revenue that is generated from the hunting and fishing outdoor segment of its business, however not all of management's decisions regarding the intent of the Field & Stream specialty store are crystal clear.

As previously mentioned, DKS's management intends to open its first Field & Stream specialty store in the Fall of FY 2013. In terms of the progress of this project, the capital needed for expansion has already been incorporated into the firm's capital budget and whether or not the store has been built has yet to be released. However, DKS's management did release that the first specialty store is going to be located in Pennsylvania. Nationwide, Pennsylvania is extremely well known for its hunting and is also home to many avid hunters. It's important to note that DKS's Field & Stream products generally lie in the lower quartile in terms of price when compared against competing brands. While lower priced products are great for some, avid hunter may display transitive preferences. This suggests there is an equal chance a fair number of hunters may choose premium products over the less expensive Field & Stream products. In addition, popular hunting locations such as Pennsylvania that are capable of attracting a sufficient customer base are also popular locations for major competitors such as Cabelas (NYSE:CAB), Bass Pro Shops, and Gander Mountain. All three of these firms provide an even higher degree of specialization containing a vast selection of products that are merely substitutes for those products that will be sold at DKS's Field & Stream specialty stores.

This brings us to the major underlying questions -- why is DKS's management actually building these Field & Stream specialty stores? It's clear the intent behind DKS's plan to expand its Field & Stream line is to increase profit margins by offering medium quality goods through its unique brand ownership, but that can be accomplished through its normal retail outlets for a fraction of the cost. The decision to establish separate retail entities suggest that management intends to either engage in direct competition with highly specialized hunting and fishing retailers or rely on brand loyalty they have built over the years with its Field & Stream line to retain customers.

I feel these specialty stores have a tremendous amount of value to add. Also, I would ignore DKS management's intent and focus solely on management's positioning strategy for where these specialty stores will be located, but the fact the first store is being placed in a concentrated area that already contains some of the largest competing retailer leaves me in question. On a different note, a rumor has it that DKS's Field & Stream specialty stores are being created to allow DKS to benefit from the sale of handguns. Currently, DKS does not sell handguns and its corporate by laws are against the sale of handguns at its normal retail outlets. However, a specialty store would eliminate this issue and provide an entirely new revenue stream. While this remains a rumor, it would be a major game changer if proven to be true. While questions and rumors remain outstanding, shareholders should have a much better idea regarding the progress of DKS's Field & Stream specialty stores by the end of this next reporting period.

Bottom Line

DKS is well positioned to excel from its surrounding growth prospects. The breadth of its product lines will enable DKS to fulfill its customer needs and maintain a strong position in the market above its peers. Additionally, future growth in revenue will be based on management's ability to execute lucrative growth options. Specifically, the outcome of its expansion projects such as its Field & Stream specialty stores. Overall, DKS has extensive room to grow and before long time will dictate the success of management's decision to build the Field & Stream specialty stores.

Sources: TD Ameritrade, Google Finance, Yahoo Finance, DicksSportingGoods.com, The Securities & Exchange Commission's Website, and Census Bureau.

Source: Dick's Sporting Goods: Its New Specialty Store May Be Major Game Changer