Seeking Alpha
Profile| Send Message|
( followers)  

As consumers become more and more health conscious and spend increasing amounts of their leisure time outdoors, Dick's Sporting Goods (NYSE:DKS) is well positioned to capture this rapidly growing trend. Many investors are not familiar with the Dick's brand name, and from an investment standpoint, that is a good thing. Buying relatively unknown companies while they are still in their growth stage has the potential to lead to outsized investment returns.

Dick's Sporting Goods is the largest full-line retailer in the sporting goods industry. With over 490 stores in 44 states, the company is quickly expanding its geographic footprint. Last year in the United States, it surpassed its closest competitors, Foot Locker (NYSE:FL) and Sports Authority, in sales by 32% and 68% respectively. Dick's carries many of the same brands its competitors do such as Nike (NYSE:NKE), Under Armour (NYSE:UA), Columbia Sportswear (NASDAQ:COLM), Callaway Golf (NYSE:ELY), and The NorthFace. What it does differently is create "shops" inside of its stores dedicated to specific brands. These "shops" carry a wider range and deeper selection of the top brand name products. This created a unique partnership which further drives sales, margins, and traffic.

Dick's further differentiates itself by creating an enhanced in-store experience unlike many of its competitors. You don't just come into a Dick's store to pick up a few golf balls. Many stores are equipped to provide the customer swing analysis, club repair, regripping, and custom club fitting. For bicycles they provide assembly, repairs, and tune ups. For outdoorsman, Dick's can provide assistance with fishing line spooling, archery lanes, and scope mounting, direct competition with Bass Pro Shops and Cabela's (NYSE:CAB). It is worth noting that Dick's Sporting Goods also owns and operates 81 Golf Galaxy stores. This article will only highlight the growth of Dick's Sporting Goods stores, which make up a larger portion of sales.

Expansion

As I mentioned earlier, Dick's currently operates over 490 retail locations. The corporate goal is to be operating 900+ stores nationwide over the next several years. The table below shows the impressive growth of stores over the past decade averaging roughly 38 new locations per year. If it continues to operate at this pace, it will take just over 10 years to reach the 900+ goal.

Store Count

Growth Rate

Store Increase

2002

141

2003

163

15.60%

22

2004

234

43.56%

71

2005

255

8.97%

21

2006

294

15.29%

39

2007

340

15.65%

46

2008

384

12.94%

44

2009

419

9.11%

35

2010

444

5.97%

25

2011

480

8.11%

36

2012 (guidance)

518

7.92%

38

Average

14.31%

37.7

CAGR

13.89%

Source: Dick's Sporting Goods SEC Filings

Store growth isn't the only way Dick's adds to revenue growth. Dick's estimates that the online market for sporting goods (domestically) is currently $5 billion and expected to grow 10-15% annually through 2016. Management intends to capture as much of this market as possible. As of the latest fiscal year, online revenue only contributed to 4% of total sales. Although this amounted to just $184.5 million in 2011, the increase year over year was 36%. 2010 saw online sales grow by 39% to $135.4 million. The company believes it can triple the current size of its eCommerce business within the next five years. The eCommerce division offers substantially higher margins than traditional retail stores.

Margins

Companies that expand as rapidly as Dick's can run into problems with expenses. The increased costs can be beneficial in the long run, but typically hurt profit margins in the short run. Dick's has done an impressive job controlling these costs. The chart below shows gross profit margins (blue line right hand scale), operating profit margins (red line left hand scale), and net profit margins (green line left hand scale). Due to the seasonality of the company's sales, you can see choppiness in margins quarter over quarter, so pay close attention to the general trend of these margins. When you smooth out the data or simply look at year over year margins, you can see all metrics increasing.

Source: Dick's Sporting Goods SEC Filings

Dick's corporate goal is to have operating margins over 10% within the next three years. It plans on achieving this goal through expanding the store base, growing the eCommerce business, improving inventory management control, and selling more private brand labels (these carry higher profit margins).

Financial Health

Dick's Sporting Goods has a very strong balance sheet. The company carries minimal debt and is not dependent on borrowing to grow future operations. Cash flow from operations has averaged $400 million for the past three fiscal years. Free cash flow, although slightly declining due to inventory purchases, has remained above $200 million over the past three fiscal years.

At the beginning of fiscal year 2011, the company initiated a dividend of $0.50 per share. The current dividend payout ratio is in the high 20% range, substantially less than that of the S&P 500 Index. I anticipate this dividend to continue growing as the company generates more cash flow over time. Simply paying a dividend while continuing to expand this rapidly shows a very financially strong company. Additionally, I wouldn't be surprised to see further share repurchases in the near future, not only to reduce stock options/awards, but as a way to return capital to shareholders.

Projections

In the table below, I have listed out my projections for the remainder of fiscal year 2012 and the following two fiscal years. It is worth noting there are many factors that went into each line item, and I tend to take a very conservative approach, so please feel free to post comments if you have questions regarding my rationale for these projections. The main points I would highlight are revenue growing at 7% this year, and then dropping by 50 basis points each of the following years. Again, these are very conservative estimates and any unexpected increase in sales would be a positive surprise. Operating margins will surpass 10% during this period as management has guided, and profit margins will maintain expansion. I assume the company will initiate a larger scale share repurchase program sometime over the next few quarters which will likely lower the basic and diluted share count. I have kept both share counts unchanged for my projection (again, conservative approach). The tax rate utilized over all periods was 39%, any decrease in this rate would be beneficial for net profit margins.

2012

2013

2014

Full Year Estimate

CS

YOY Growth

Full Year Estimate

CS

YOY Growth

Full Year Estimate

CS

YOY Growth

Revenue

$ 5,576,628,140

100.00%

7.00%

$ 5,939,108,969

100.00%

6.50%

$ 6,295,455,507

100.00%

6.00%

Cost of Revenue

$ 3,786,916,287

67.91%

4.70%

$ 3,961,114,436

66.70%

4.60%

$ 4,139,364,586

65.75%

4.50%

Gross Profit

$ 1,789,711,853

32.09%

12.22%

$ 1,977,994,533

33.30%

10.52%

$ 2,156,090,921

34.25%

9.00%

Selling, General and Admin Exp

$ 1,240,129,440

22.24%

8.00%

$ 1,326,938,501

22.34%

7.00%

$ 1,413,189,503

22.45%

6.50%

Pre-opening expenses

$ 18,241,250

0.33%

25.00%

$ 22,801,563

0.38%

25.00%

$ 28,501,953

0.45%

25.00%

Operating Income

$ 531,341,163

9.53%

22.99%

$ 628,254,470

10.58%

18.24%

$ 714,399,465

11.35%

13.71%

Interest Expense

$ 13,590,640

0.24%

-2.00%

$ 13,318,827

0.22%

-2.00%

$ 13,052,451

0.21%

-2.00%

Pretax Income

$ 517,750,523

9.28%

19.84%

$ 614,935,642

10.35%

18.77%

$ 701,347,014

11.14%

14.05%

Provision for income taxes

$ 201,922,704

3.62%

20.11%

$ 239,824,901

4.04%

18.77%

$ 273,525,336

4.34%

14.05%

Net Income

$ 315,827,819

5.66%

19.67%

$ 375,110,742

6.32%

18.77%

$ 427,821,679

6.80%

14.05%

Basic Shares Outstanding

120,000,000

120,000,000

120,000,000

Basic EPS

$ 2.63

$ 3.13

$ 3.57

Diluted Shares Outstanding

125,000,000

125,000,000

125,000,000

Diluted EPS

$ 2.53

$ 3.00

$ 3.42

There are many assumptions not factored into my projections above that have the potential to provide an additional boost to earnings:

  • eCommerce sales growing faster than expected and reducing expenses.
  • Paying off existing debt (this will reduce interest payments).
  • As cash on the balance sheet continues to grow, a portion may be shifted to short-term interest bearing investments.
  • Recent investment in JJB Sports was purchased for $32 million and written down to $0. Any increase in the value of this available-for-sale investment could be used to boost earnings.

Valuation

Assuming the projections I have laid out above prove to be correct, shares of Dick's Sporting Goods have the potential to offer attractive returns for the next few years. Currently, shares of DKS trade at 25x trailing twelve month earnings, taking the projected diluted FY14 EPS of $3.42 and utilizing the following P/E multiples would warrant the following stock prices and returns two and a half years from now:

-$3.42 X 22x (TTM P/E) = $75.24 share price, 16.83% annualized rate of return

-$3.42 X 20x (TTM P/E) = $68.40 share price, 12.46% annualized rate of return

-$3.42 X 18x (TTM P/E) = $61.56 share price, 7.82% annualized rate of return

Again, my assumptions tend to be very conservative. Any upside surprises could warrant the market awarding shares of DKS with higher multiples. I also did not include the quarterly dividend payment, which if reinvested would add to your annualized rate of return. I expect this dividend payment to increase over time as the company grows earnings and generates more cash flow.

Conclusion

While shares of Dick's Sporting Goods are by no means a risk free investment, nor are any of the returns I mentioned above guaranteed, I believe this company has room to grow and offers value at current price levels. Dick's faces many risks including but not limited to; slowdowns in consumer spending (especially with regards to outdoor recreation spending), over expansion, increased competition from online retailers, the loss of relationship with a major brand label.

Consider your investment goals and objectives before initiating a position in Dick's Sporting Goods. If you see a fit in your portfolio, I think being a long-term shareholder will provide attractive returns. In my opinion, we are in the early innings of this company's growth story.

*Note: All data reported and graphed is pulled directly from Dick's Sporting Goods website, press releases, and SEC filings (10K's and 10Q's).

Source: Double-Digit Returns For Dick's Sporting Goods