Sportsman´s Warehouse (SPWH) is a relatively small outdoor growth play in specialty retail, a market which has been struggling a bit as of late. Following year of impressive comparable sales growth when the company was held in private hands, operational performance has been lagging since the company went public in the spring of 2014.
Despite the slower comparable growth, Sportsman´s continues to grow as it expands its store base, working against both formidable retailer competitors and of course the emergence of online shopping.
Despite these challenges, Sportsman´s continues to grow and actually trades at a non-demanding earnings multiple, explained by secular challenges, a creation of a more formidable competitor through recent M&A action, and a fairly elevated leverage position. Despite these concerns, today might be an opportunistic time to initiate a modest position in this retailer.
Outdoor Sporting Goods Retailer
Sportsman´s is an outdoor specialty retailer which offers a one-stop shopping solution, tailored to local demand and conditions. The company is mainly focused on Western US, running a store base of 75 stores at the moment. Over time, the company sees room to operate some 300 stores across the US.
The company estimates that the national market for outdoor sporting goods has a size of more than $50 billion, of which a third is controlled by national retailers, in a market still dominated by mom and pop retailers. Key competitors which public include Cabela´s (NYSE:CAB) and privately held Bass Pro Shops, among others. These competitors are much larger, a trend reinforced by the merger announced between both firms.
In order to meet the long term potential Sportsman aims to grow the unit store base by 10% in the long run, after being quite active with regard to store openings in recent years. Between 2010 and 2016, Sportsman has tripled the store base. This physical expansion was complemented by comparable store sales growth of 13 to 25% in the years 2010-2012, being a very impressive achievement. Following these strong years, comparable sales were down in 2013 and 2014, only to become quite flattish thereafter.
Struggling Since Its Public Debut
Sportsman´s has been struggling since it has gone public in April of 2014. This followed negative same stores sales growth rates reported in 2013 and 2014, causing concerns among some investors given that the company employed quite a bit of debt.
Shares traded around $10 in April 2014 when the company went public, only to lose half their value by that summer. Ever since shares have recovered, mostly trading in a $8-$14 range since the summer of 2015, with shares trading towards the lower end of the range at the moment.
The company just released its third quarter results which were relatively solid. Topline sales were up by 13% towards $217.2 million, mostly driven by new store openings with same store sales having risen by 2.1%. This followed relative flattish same store sales results in the first half of the year. While the slight acceleration is good news, the industry remains highly promotional, pressuring margins of the business. Despite the solid third quarter results, the outlook remains mixed as fourth quarter comparable store sales are expected to come in flat, plus or minus a percent.
If that is realized, full year sales are seen at $789-$794 million, with earnings expected around $31 million, equivalent to $0.72 to $0.75 per share. With shares trading at little over $8 apiece, that translates into a non-demanding 11 times earnings multiple.
Part of the low multiple is the result of the fiercely competitive marketplace as well as the state of the balance sheet. Despite the current profits, deleveraging is not going very quickly following relatively large capital expenditure requirements relating to continued opening of new stores. Net debt stands at $254 million, if we include rent obligations. That results in a leverage ratio of little over 3 times adjusted EBITDA.
What Is The Normal?
Sportsman is currently valued at roughly $600 million, being the value of outstanding equity and net debt. This valuation is equivalent to roughly 0.75 times sales, 7.5 times EBITDA, as equity trades at 11 times earnings. Investors face some anxiety with regard to the future, as operating margins have fallen from 10% of sales in recent years to just 7.5% by now.
Competitor Cabela, which is much bigger, is a $4.2 billion business which posts margins of 7%. It was valued by Bass Pro at $5.5 billion in a recent deal, translating into a 1.3 times sales multiple. Given the similar operating margin profile of Cabela and Sportsman, that sales multiple marks a 70% premium compared to the valuation at which Sportsman is trading.
The key to unlock part of this differential valuation is cash flow management and continued growth, in my opinion. Note that full year earnings are seen around $30 million in absolute terms, yet all of these earnings go towards investments into the business. Capital spending requirements come in at roughly $35 million a year, offset by merely $10 million in depreciation charges.
Another key factor is the built-up in inventory levels, being up 40% year-over-year towards $304 million. If inventory growth would be in line with sales levels, Sportsman could have cut inventory levels by roughly $60 million, having a meaningful impact on leverage ratios. That being said, it is not really bad inventory management which hurt the firm, as last year´s inventory levels were too low to cater its customers effectively.
Sportsman´s is arguably an appealing investment at 11 times earnings, while store expansion lays out a pathway to future growth. Key risks are evident as well including a fairly elevated leverage profile, soft cash flows resulting from projected growth, and online competition which potentially results in shrinking margins.
The company claims that it can compete effectively with online retailers, citing that customers prefer to come into the stores and that a third of merchandise cannot be easily be found online, while stores offer competitive prices as well. Another key factor in the investment thesis is the merger between Cabela and Bass Pro. Executives of Sportsman´s indicate that 40% of the stores of the new combination will have multiple stores within a 50 mile radius. This leaves potential for elimination of competitor´s stores or expansion opportunities for Sportsman. The deal could be distracting as well of course with regard to operational execution, as the new combination will be fairly leveraged.
Weighing it all together, I think that investors should be optimistic at these valuations. Valuation multiples are low and the path to future growth is clear, as these factors should outweigh above-average leverage, concerns about a more formidable competitor and continued emergence from online competition. With shares down a third so far this year, a small opportunistic investment might be warranted.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SPWH over 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.