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Industry Introduction

Historically, sporting goods stores were small, family-owned businesses that serviced the needs of the local community. Wholesalers were the primary suppliers of merchandise, and operators had little or no competition from other retailers because of their high level of specialization. During the past two decades, the arena for sporting goods retailers has changed, with industry players evolving into national chains that have considerable buying power. The rise in sporting chain numbers has created an opportunity for mass merchandisers to seek a market share, with retailers benefiting from their ability to offer consumer-specific brands.

Key drivers

  • Rising consumer awareness of good health: Rising consumer awareness of good health and increased participation in sports have led to increased revenue growth for the industry.
  • Increasing levels of competition: from department stores and mass merchandisers have restrained industry growth in recent times.
  • Disposable Income: A drop in disposable income during the recent recession has led to shaky consumer confidence, as well as a slowdown in industry sales. However, industry sales are expected to find some momentum with the economy slightly recovering.

Foot Locker, Inc. (NYSE:FL)

Foot Locker, Inc. is a retailer of athletic footwear and apparel. The company operates in two segments, Athletic Stores and Direct-to-Customers. The Athletic Stores segment retails athletic footwear, apparels, accessories, and equipment under various formats. As of January 28, 2012, it operated 3,369 stores in 23 countries in North America, Europe, Australia, and New Zealand. The Direct-to-Customers segment includes CCS and Footlocker.com, Inc., which sell athletic footwear, apparels, equipment, team licensed products, and private-label merchandise through catalogs, mobile devices, and Internet Websites. The company also provides franchise licenses to open and operate its Foot Locker stores in the Middle East and the Republic of Korea.

Expanding margins: The company has shown impressive growth in margins, both on a quarterly and an annual basis. In the recent quarter ended April, 2012, gross margins rose to 34% from the previous quarters 32% with total sales increasing almost 9%. Overall, the athletic store segment of the company performed well showing growth in sales, with the exception of the European Division, which actually saw a decline in the quarter. The commonly cited the reason being the current economic struggles of the region. The company's online wing showed impressive growth as well, mainly due to increase in its internet sales.

Earnings on the rise: The company reported earnings per share of $0.83 in 1Q2012, 38% higher than the previous year's EPS. The reported EPS was not only higher than the previous one, but also beat the consensus analysts estimates of $0.74, providing a surprise of almost 12%.

Liquidity and capital requirements under control: The company has a cash balance of almost $900 million with not a significant amount of debt, currently at around $135 million and a reasonable debt to equity ratio of 6%. Moreover, the company's cash flows from operations have shown an impressive growth since last year, growing by almost 50% in the FY2011. Cash flows from operations did decline in the recent quarter, however, due to the timing of income tax payments. Overall, with sufficient cash and growing CFO, the company should feel comfortable regarding its working capital and capital expenditure requirements going forward. The company has also announced its share repurchase plans of $400 million, which is well supported by its cash flow position. Moreover, it offers an attractive dividend yield of 2.40%.

Market Performance: The stock has performed well and has continued on an upward trend over a period of one year. It has yielded almost 30%, beating its peers like BKRS, SCVL, and FINL.

Valuation: The company's P/E is at a 35% discount to the industry as well as its five year average, indicating it is currently undervalued. Other multiples like price-to-sales and price-to-book are also at a discount to the industry averages, indicating the stock has value.

Conclusion: The company has performed well in terms of revenue growth and expanding margins. It has managed inventory well, thus further enhancing its margins. A strong balance sheet with ample cash for dividend payouts (dividend yield of 2.40%) and share repurchases is a positive for the company and its stock. Its market performance over the years has been steady and based on the company's impressive earnings growth, we recommend a long position in the stock.

Finish Line Inc. (NASDAQ:FINL)

Finish Line, Inc., together with its subsidiaries, operates as a mall-based specialty retailer in the United States. It operates Finish Line stores that offer performance and athletic casual footwear, apparel, and accessories for men, women, and children. The company also sells merchandise through its Website, finishline.com. As of September 22, 2011, it operated 646 stores in the United States.

Expanding margins: Gross margins for FINL are impressive at almost 35%, which ranks above most of its peers, including Foot Locker. Moreover, the gross margins are also following an upward trend and are currently close to their five-year high, which indicates that the company is doing well.

Consistent growth in sales and earnings: Sales of the company have increased at a rate of 11%, which is higher than the 9% increase in its cost of sales. FINL'S rise in sales was largely driven by increase in store traffic, additional days of sale and a rise in comparable store sales.

The company reported an EPS of $1.59 in FY2012, an increase of around 26% from the previous year. FINL has updated its outlook for the first quarter ending June 2, 2012. It now expects first quarter comparable store sales to increase by 8.5% and the EPS to be between $0.22 and $0.23. This compares to its previous outlook for comparable store sales to increase in the mid-single digit range and EPS of approximately $0.21.

The company has a debt free balance sheet and a cash balance of around $308 million, which is an increase of over $8 million from FY2011. Net cash provided by operating activities decreased by $13.9 million in 2012 compared to FY2011. This decrease was primarily attributable to working capital changes, including an incremental buildup in inventory of $21.3 million.

Market Performance: Even though the stock has lost some of its value since the start of the year, it has outperformed its competitors over a long term horizon, indicating the value of holding the stock long term.

The management is focusing increasingly on technology and digital capabilities and has invested substantially to improve its customers' digital experience. The company plans to invest $41 million in technology, which is around 50% of its total capital expenditures for the year. However, this increased investment is likely to lead to a contraction in the company's margins, which could have a damaging effect on its EPS in the near term.

Conclusion: The company's P/E as well as other multiples like price-to-sales and book are at a discount to the industry, indicating the stock is undervalued. Moreover, the stock is trading close to its 52-week low of $16.40, which could prove to be a good entry point. FINL's strong balance sheet, impressive growth in sales and earnings and attractive valuation levels make a strong case in favor of taking a long position on the stock.

Nike Inc. (NYSE:NKE)

Nike engages in the design, development, marketing, and sale of footwear, apparels, equipment, and accessory products for men, women, and children worldwide. The company offers products in the categories of running, training, basketball, soccer, and sports-inspired casual shoes. The company has total cash of around $3 billion and a debt-to-equity ratio of only 4%. NKE has posted impressive gross margins YoY (46% in 2011 versus 35% for FINL and 32% for footlocker) and is expected to continue to expand. In the most recent quarter, the company's revenues increased. However, it missed the analyst estimates. Read our analysis on NKE here.

Adidas AG (OTCQX:ADDYY)

Adidas AG engages in designing, developing, producing, and marketing a range of athletic and sports lifestyle products worldwide. It offers footwear, apparels, and hardware, such as bags and balls, primarily under the Adidas and Reebok brands. The company operates in six segments: Wholesale, Retail, Taylor made-Adidas Golf, Rockport, Reebok-CCM Hockey, and Other Centrally Managed Brands. The company has total cash of almost $2 billion as of the most recent quarter, and a relatively high debt-to-equity of 30%. Quarterly earnings growth of 38.30% for the company are impressive, however, the stock has underperformed NKE on a YTD basis.

Key Financials

NKE

ADDYY

FL

FINL

Market Cap:

45.36B

14.98B

4.45B

965.49M

Qtrly Rev Growth (yoy):

0.15

0.17

0.09

0

Revenue (TTM):

23.42B

17.65B

5.75B

1.37B

Gross Margin :

0.44

0.47

0.44

0.41

EBITDA :

3.46B

1.73B

605.00M

163.53M

Operating Margin :

0.13

0.08

0.09

0.1

Net Income :

2.27B

953.96M

312.00M

84.11M

EPS :

4.79

2.27

2.03

1.59

P/E :

20.64

15.75

14.48

11.69

PEG (5 yr expected):

1.54

2.84

0.87

0.81

P/S :

1.93

0.87

0.77

0.71

Source: Which Sporting Goods Stocks To Buy?