One of the reasons our members love us is that we tell the story through the numbers. Every income statement says something, every balance sheet has a history and every cash flow statement reveals a firm's true intrinsic value. The numbers talk--and we think every investor should listen to them. Let's see what they say about Dick's Sporting Goods (NYSE:DKS).
But first, a little background to help with the understanding of this piece. At Valuentum, we think a comprehensive analysis of a firm's discounted cash-flow valuation, relative valuation versus industry peers, as well as an assessment of technical and momentum indicators is the best way to identify the most attractive stocks at the best time to buy. This process culminates in the Valuentum Buying Index, which ranks stocks on a scale from 1 to 10, with 10 being the best. If in-depth academic research on our process is your fancy, please click here.
Essentially, we're looking for firms that overlap investment methodologies, thereby revealing the greatest interest by investors (we like firms that fall in the center of the diagram below). At first, this may sound strange, but we think it is genius in its simplicity. By focusing on what drives stock price movement, namely valuation and technical/momentum analysis, we position our members to identify the stocks that are most likely to appreciate. Said differently, all investors are interested in stocks that go up. We think those stocks are ones that are underpriced and are just starting to get noticed by the investment community as being so. More interest in the shares by various investment methodologies --> more buying in shares --> greater likelihood of price-to-fair value convergence. Though we show our work like all good students do, it doesn't get more simple than that.
If a company is undervalued both on a DCF and on a relative valuation basis and is showing improvement in technical and momentum indicators, it scores high on our scale. It's about as straightforward as it gets. Dick's Sporting Goods posts a VBI score of 3 on our scale, reflecting our 'fairly valued' DCF assessment of the firm, its neutral relative valuation versus peers, and bearish technicals. For relative value purposes, we compare Dick's Sporting Goods to peers Big 5 (NASDAQ:BGFV), Hibbett (NASDAQ:HIBB), and Cabela's Inc. (NYSE:CAB). Though relative valuation techniques and the use of the price-to-earnings ratio itself has faults, we think the process is a good check against the discounted cash-flow process. All that said, let's dig into the report.
Our Report on Dick's Sporting Goods
Dick's Sporting Goods' Investment Considerations
Dick's Sporting Goods' Investment Highlights
- Dick's Sporting's business quality (an evaluation of our ValueCreation™ and ValueRisk™ ratings) ranks among the best of the firms in our coverage universe. The firm has been generating economic value for shareholders with relatively stable operating results for the past few years, a combination we view very positively.
- Dick's Sporting Goods is a full-line sporting goods retailer offering a broad assortment of brand name sporting goods equipment, apparel and footwear. The company owns and operates Golf Galaxy, a golf specialty retailer.
- The US retail sporting goods industry is stable and predictable and has grown at roughly a 2% compound annual growth rate since the early 2000s. Dick's Sporting Goods, however, has grown at a high-teens growth pace during the same time period.
- Over 20,000 firms operate in the US retail sporting goods industry, but less than 200 have more than five stores. Dick's Sporting Goods thinks the US market is large enough for more than 900 of its stores, offering significant growth opportunities.
Dick's Sporting Goods' Business Quality
Dick's Sporting Goods' Economic Profit Analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (NASDAQ:ROIC) with its weighted average cost of capital (OTC:WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Dick's Sporting's 3-year historical return on invested capital (without goodwill) is 24.8%, which is above the estimate of its cost of capital of 10.8%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Dick's Sporting Goods' Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Dick's Sporting's free cash flow margin has averaged about 3.6% during the past 3 years. As such, we think the firm's cash flow generation is relatively MEDIUM. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Dick's Sporting, cash flow from operations increased about 12% from levels registered two years ago, while capital expenditures fell about 0% over the same time period.
Dick's Sporting Goods' Valuation Analysis
The estimated fair value of $49 per share represents a price-to-earnings (P/E) ratio of about 21.2 times last year's earnings and an implied EV/EBITDA multiple of about 9 times last year's EBITDA. Because we receive a whole host of questions about how we think about forecasts, please click here for some background. Our model reflects a compound annual revenue growth rate of 7.4% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 9.8%. Our model reflects a 5-year projected average operating margin of 10.1%, which is above Dick's Sporting's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 3.3% for the next 15 years and 3% in perpetuity. For Dick's Sporting, we use a 10.8% weighted average cost of capital to discount future free cash flows.
Dick's Sporting Goods' Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $49 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Dick's Sporting. We think the firm is attractive below $39 per share (the green line), but quite expensive above $59 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion. We think this aspect of our research is among the most valuable. As we saw during 2013, companies' share prices can advance rapidly. Without a fair value range in stock analysis, the optimum 'consider buying' and 'consider selling points' cannot truly be derived. We find this analysis to be extremely helpful in volatile industries -- those with significantly volatile input and output costs.
Dick's Sporting Goods' Future Path of Fair Value
We estimate Dick's Sporting's fair value at this point in time to be about $49 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Dick's Sporting's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $65 per share in Year 3 represents our existing fair value per share of $49 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.