Shorting Dick's Sporting Goods on Under Armour Weakness

After posting about Under Armour (UA) earlier in the week, I thought it would be fitting to look closely at one of their primary distributors, Dicks Sporting Goods (DKS). As the dust is settling from the Under Armour quarterly report, it appears Wall Street was initially excited about the quarter, but upon further review, the stock is much lower and the weakness showed up before the overall market decline this Thursday. Dicks will likely trade in line with Under Armour until their own report which is not currently scheduled but will likely be on or near November 21.

The primary culprit driving weakness in shares of UA and DKS appears to be weather patterns. Typically sporting good stores get a good bit of traffic in the fall as athletes gear up for cooler weather. The winter products typically carry higher margins as fleece and heavy coats top the list of profitable items. Last fall the cool weather came earlier in the season allowing more sales in Q3. This makes a tough comparison as weather has not driven as many to beef up their winter wardrobes and sales are likely to be slower. Many analyst brush off light Q3 sales stating that whatever is not sold this quarter will simply flow through to next quarter when the weather will certainly be more of a catalyst.

This theory is brought into question after reading Credit Suisse’s report which noted that inventories were relatively high and stores that the analysts toured had a number of discount racks with winter attire at significantly reduced prices. If stores are discounting the merchandise to move the product, they stand the risk of selling the same merchandise that analysts are expecting to be sold in Q4 - only at reduced prices now. This will likely be slowly realized over the next few months as different apparel and sports retailers report monthly sales figures and inventory data. Each report could be an important event for DKS which will likely be news driven for the next few months.

Additional concerns surround gas prices which continue to take a larger chunk of discretionary spending out of consumers wallets. While the peak oil prices from the last month have not yet affected pump prices, they will eventually work their way through as refining spreads are extremely narrow. Unless oil drops significantly, it would not be surprising to see another 20% rise in energy costs. Energy costs have not hampered consumers up to this point, but with credit becoming less available the consumer may not have as many options. With more credit cards being maxed out and no new offers for balance transfers in the mailbox, Mr. and Mrs. Smith may find themselves tapped out and less likely to spend on sporting goods among other items.

DKS has some positive data points, however, and should only be shorted with caution. For one, the company has little exposure in the states with the largest housing declines. In California, Texas and Florida; there are only nine stores represented. Management will likely expand into these states in the future, but they have been wise (or lucky) enough to bypass these turbulent markets so far. The majority of Dicks stores are young (4.5 years on average) and the company has spent a good bit investing in remodels which gives the storefront a very appealing look. This should help the company increase market share even if the overall industry becomes weaker.

After UA began turning lower, I put a short position on DKS. This is in the context of a portfolio that has taken advantage of a good bit of the recent rise in stocks. I have a cautious position and will only add to it if I have confirmation that the trend lower is in place, but at this time I think the risk of lower prices is one that should be carefully considered.

Disclosure: Author has a short position in DKS