Dick's Sporting Goods (DKS) and Big 5 (BGFV) pre-announced dismal guidance for the fourth quarter of 2011. Though both companies cited a lack of winter weather as the main driver of poor same-store sales, we think the stories at each company are quite different. Dick's remains a steadily growing, well-run business focusing on driving high returns on invested capital whereas Big 5 is an inferior player focusing on smaller markets that's struggled to find its way.
Risk/reward at Dick's Sporting Goods isn't very compelling right now
With our fair value of Dick's at $31 per share, and the stock above $40, we aren't very interested in the company at this time. It trades at only about 18x our 2012 forecast; however, we do not see the same years of explosive growth ahead. Stores are performing exceptionally well, riding a generational boom of running, yoga, and fitness, and the company benefits greatly by carrying leading brands Nike (NKE), Under Armour (UA) and Adidas (OTC:ADDDF).
While these companies continue to create great products that fly off shelves, Dick's still does a great deal of business in sporting goods and equipment, which seem to be pretty flat. The NFL-Nike equipment deal could provide a boost in lapping difficult Q3 sales, but overall, the best way for Dick's to grow is to open new stores.
The company's done a fantastic job of expanding at a reasonable pace, but as new markets become more scarce, it could be difficult for Dick's to avoid oversaturation. Additionally, though we do not think sporting goods and apparel retail is as ready to move online, as say, books and movies, Dick's continues to grow its online business at 20%+ annually. It still has a ways to go to catch Footlocker (FL) owned Eastbay as far as ease of use and selection goes, but on the web, there aren't many other reliable options.
Big 5 is getting cheap again, and the dividend could pay you to wait out the storm
Big 5 is an entirely different story from Dick's. We've previously outlined why we think Big 5's store strategy holds some interesting competitive advantages, but the company has really struggled to get its act together recently.
Management noted in its last press release that gross margins fell 190 basis points for the quarter. Additionally, it guided earnings down to the $0.55-$0.58 range for the year--from a normalized earnings per share of $1.01 last year. The near 60% decline in its stock price seems justified.
We have lowered our full-year forecast for 2012, but we still think this company is worth a look, but at lower price levels. Its key markets like California, Nevada, and Arizona, still have the worst employment numbers in the U.S., and the lower-end consumer that Big 5 often serves hasn't yet come back. This is evident at low-end retailers everywhere, including Payless Shoes [owned by Collective Brands--(PSS)] that have struggled mightily to drive positive same-store sales. With housing looking rosier, good earnings from JP Morgan Chase (JPM) and unemployment falling, the near-term future is looking a little bit brighter.
If the economy can start to pick up, specifically in these markets, same-store sales could surprise to the upside (and discounting could subside), allowing gross margins to return to their traditional range nearer 33%-34%. In the meantime, Big 5's stock yields about 3.8%, with a Valuentum Dividend Cushion above 1, which is surprisingly high given the company's high debt level. If shares fall below $7, as they did in August, the yield grows to well over 4%, which looks much more attractive.
Nevertheless, we would wait for a higher margin of safety and dividend yield before entering such a high-risk name. Its relatively small size could make it an attractive purchase for private equity (The Sports Authority is owned by a private equity firm and Big 5 has been in the past). However, we prefer to invest in companies on the basis of their underlying fundamentals and valuation (not on the prospects of a buyout), and we'd only grow interested in Big 5 under $7 per share, the low end of our fair value range.