Hibbett Sports - Stay Far, Far Away
Summary
- Shares of Hibbett Sports trade at a discount to peers from an EV/EBIT, P/E, and P/FCF standpoint. However, the discount is warranted.
- Both near and long-term outlook appear negative for the company, and management is struggling to respond to the changing retail environment.
- The changing retail landscape will prove to be disastrous for the small-town brick and mortar business. Shares have room to drop from here.
- Price: $12.85, P/E: 6.3, TEV: $211.8m, Shares outstanding: 20.3m, EV/EBIT: 2.45 TTM.
Description of the potential opportunity
Hibbett Sports (NASDAQ:HIBB) represents a value opportunity in the form of a small-town sporting goods retailer whose share price has plummeted due to declining comps and overall fear surrounding the retail sector.
Despite a recent uptick, the SPDR S&P Retail ETF (XRT) (which holds HIBB, Dick's Sporting Goods (DKS) and Foot Locker (FL) among others), has taken a decent nosedive over the past year due to skepticism surrounding brick and mortar stores being able to compete with quicker, cheaper, and more convenient online and mobile options such as Amazon (AMZN).
Source: Yahoo Finance
As many of the companies in the index suffer continuous sales declines, they have been forced to lower prices via promotions/discounts to move inventory, which has resulted in depressed margins, which has led to lower SSS numbers, which forces them to reduce prices even further to attract customers and move inventory - and over a period of time, these companies are caught in a downward spiral that shows no signs of a near term slowdown.
Companies like Hibbett, Dick's Sporting Goods, Foot Locker, and Finish Line (FINL) have seen their share prices decline anywhere from 40-60% YTD as consumer preferences for footwear and apparel change (and what they're willing to pay), mall visits slow down, and mobile shopping becomes more prevalent.
As a result, plenty of money has since moved out of the sector, taking good companies with strong operating histories and solid balance sheets along with it. Unless one has been living under a rock, this is hardly new information, yet seems to be representative of the rapidly changing retail landscape.
That brings us to Hibbett Sports. Because of the fear and uncertainty regarding this new retail environment, Hibbett stock price has been hammered starting in December of 2016, down nearly 65% on a 52-week basis, dropping from around $40 per share to below $14 where it sits today.
Given the monumental price drop, it appears as though we've reached maximum pessimism, especially for a specialty apparel company that caters to small-town sports fans, operates small-box stores (less than 5,000 sq. ft.) and may be uniquely positioned to stay competitive despite the trend of shopping traffic moving from brick and mortar to online and mobile. Furthermore, the company trades at a solid discount to its big box competitors from an EV/EBIT, Price/FCF, and earnings multiple standpoint.
Source: Author data
On the surface, this looks like an interesting opportunity to participate in the potential re-rating of the company's multiple in line with its peers, in addition to possible SSS recovery. For the last decade, Hibbett Sports has been a solid business with a strong operating history, experienced management that appears to be rational, while currently sporting a net cash position which makes up nearly 20% of its market cap, no debt, and a heavily discounted share price.
The downside appears to be minimal given the low multiples, strong balance sheet, development of omni-channel sales platforms, ability for the company to buy back shares at depressed prices, and sales mix heavily skewed toward footwear, a resilient category that can still command premium pricing.
Or, this could be a complete value trap, which is how we currently view the business. Investors would be wise to stay away from HIBB, or initiate a small short position, given declining fundamentals and weak outlook moving forward.
Company overview and business description
Hibbett Sports (in the company's words) is an athletic specialty retailer operating predominantly in small to mid-sized markets, in the South, Southwest, Mid-Atlantic, and Midwest regions of the United States. The company provides an extensive selection of premium brand footwear, apparel, and team sports equipment, emphasizing convenient locations and a high level of customer service. As of July 29, 2017, the company had 1,080 retail stores in 35 states composed of 1,061 Hibbett Sports stores and 19 Sports Additions athletic shoe stores.
The company's stores are primarily located in strip centers, next to a major chain retail anchor (mostly Wal-Mart (WMT)), but it also operates 190 enclosed mall locations, and 26 free-standing stores. The company operates 5,000 sq. foot stores (small-box) and caters primarily to the small-town sports fan with a variety of shoes, team merchandise, and equipment.
Put simply, the company is an athletic clothing retailer that derives the majority of its sales from footwear. The company's strategy to date has been to position itself next to a large major chain retailer (Wal-Mart) that generates plenty of foot traffic, entice those customers by offering an assortment of quality and new athletic apparel, prove a successful location, then build new stores and repeat.
2003: Then-CFO Gary Smith told Marianne Bhonslay of Sporting Goods Business,
We have a good growth record with a simple model. But it works.
Since 2010 (when current CEO Jeffrey Rosenthal started), the company has grown from 767 stores and sales of $593 million, to 1,080 stores today with sales of nearly $1 billion ($972 million).
The company has accomplished this despite not having any online or mobile presence, having just launched its e-commerce platform as recently as Q2 2017.
Since Rosenthal took over, the company's results speak for themselves. New store growth, top and bottom line, and gross margins have been up and to the right, just how investors like it.
Source: HIBB 2017 Annual Report
New store openings and organic growth over the last decade reflects the company's unique positioning in their end markets. Being the 'small-town' sporting goods and apparel retailer in the areas that aren't strong enough to carry a big box store is what allowed Hibbett to earn high returns on invested capital of >20% for the last 10 years.
The competitive environment for sporting goods and apparel in retail is fragmented, so specific market share numbers for Hibbett could not be determined. We could take the total retail sales/market size for sports apparel in 2017 (roughly $165 billion), use bigger competitor numbers to derive relative market share, and then back out a number for Hibbett, but we'd be wrong. My guess is the company controls less than 1% of the sports apparel market globally.
Company background
Hibbett Sports was founded in 1945 by Rufus Hibbett, a high school coach and teacher from Florence, Alabama. The company's original name was Dixie Supply company, until Hibbett's sons joined the business. The company name was then changed to Hibbett and Sons until the 1960s, before transitioning over to the present-day Hibbett Sports Inc.
In 1980, the Anderson family of Florence, Alabama purchased the company, invested in professional management and systems and began to expand the store count at a modest rate.
From inception, the company's original strategy was to target small to mid-size markets with smaller populations where it's bigger box competitors couldn't profitably operate new locations. This provided the company with strategic advantages including expansion opportunities, lower operating costs, and less competition, given the fact that it wasn't trying to go head to head with companies like Big Five, Dicks, and Sports Authority.
Although the company started to experience rapid growth through the 1990s, the store count remained small, with just 60 stores in 1995. This was however up from 38 in 1993. Sales at the end of 1994 were $40.1 million.
It wasn't until the company's owning family, the Andersons, sold the business to Saunders Karp & Co., an investment firm, that there was talk of going public. In the same year of the completed sale, Saunders Karp & Co. oversaw the opening of the first Hibbett Sports 'superstore', a 25,000-square foot store selling a mix of apparel and athletic equipment.
The growth in store count as well as store variety required expanded inventory and larger operating facilities. This need led Hibbett to build its 130,000-sq. foot office/warehouse/distribution facility in Birmingham in 1996. The distribution process then became centralized, and the low-cost operating structure was put into place.
The company went public in 1996, and from their IPO price of $16/share, had you held to present day, you would have experienced a total return of -1%. Despite the more recent performance, there were positive moments for the share price as the company was growing rapidly and building out new stores. The stock went from $15 in 2008 all the way up to $67 by 2013. Unfortunately, the shares have been in a free fall since.
The company's policy, put in place after the IPO, was to institute a 'clustered expansion program', which called for opening new stores within a two-hour driving radius of another company location, in order to make efficient the distribution, marketing, and regional management of each store. This was a great strategy at the time and was obviously put into place pre-internet.
The company carried a large variety of brand name merchandise throughout the 1990s, which at the time exceeded the selection of local independent competitors. Pre-internet, it was important to have a sales person or staff member available in-store in order to provide customer assistance. Contrast that to today, where many people research products online or via mobile and tend to know what they want before walking into most stores. In some cases, a sales person can be considered a nuisance.
In 1997, the company's largest vendor was Nike (NKE), representing 40% of supplier purchases. Today, Nike represents 56.8% of the goods purchased to line the shelves. Under Armour (UAA) comes in at a close second.
The company's strong competitive advantages pre-internet, which allowed it to achieve 30 years of profitable retailing in small to mid-sized markets were as follows:
Wide selection of branded products - deep breadth of quality merchandise Hibbett were usually the primary retailers of a full line of sporting goods in their markets
- For example, when Nike needs to put shoes in a store in small-town Alabama, it is going to call Hibbett first Superior customer service - staff was available and educated to explain products Concentration on smaller markets - limits competition to independents and national footwear chains. Hibbett can better serve their customer base Open stores next to the retail center anchor, Wal-Mart
- Provides the company with the same foot traffic, where Hibbett offers a much wider selection of merchandise and footwear
In the company's 1998 annual report Hibbett President Michael J. Newsome commented that there were three options open to retailers in the sporting goods industry:
Stand idly on the sidelines and let the world pass you by; 'slug it out' for incremental market share; or cater to a genuine need. We prefer the latter.
The mom-and-pop usually specializes in the team and school business. Because we're retail athletics, we don't necessarily put anybody out of business, we don't really bother the mom-and-pops in regard to their team and school business--that's not what we do. We do the retail, so we coexist very well with the mom-and-pops, but that's typically our number-one competitor.
So again, the company stopped trying to compete with the big boys such as Dick's, Sports Authority, or Big Five (BGFV), and it was working.
Business strategy
The sports apparel business is competitive and fragmented, with low barriers to entry. New entrants pop up all the time, ranging from specialty apparel companies (see Lululemon (LULU)) to direct to consumer independent brands (for shoes, see AllBirds or No Bull). With a small-town appeal, ability to hire cheaper labor, no e-commerce presence (and thus no logistics/distribution costs for shipping), and a focus on higher priced footwear, HIBB was able to earn EBIT margins well in excess of its competitors, posting a high of 14.1% in 2013, versus 8.7% for Dicks, and 4.9% for Big Five Sporting Goods. The company's original strategy was to target small to mid-size markets with smaller populations where it's bigger box competitors couldn't profitably operate new locations. Their fixed cost base of rent and labor allowed them to succeed in doing this for many years.
This provided the company with strategic advantages, including expansion opportunities, lower operating costs, and less competition, given the fact that it wasn't trying to go head to head with their bigger competitors who carried more and a wider variety of merchandise, but had higher costs to do so. Hibbett's return on assets has dwarfed its competitors for some time now.
This regional focus allowed the company to accomplish a few things:
It became known by vendors as the 'it' clothing and sporting goods retailer in these smaller markets. The regional focus allowed the company to achieve some cost benefits, including lower corporate expenses (current revenue per employee is $303,000 versus Dicks which is $220,000), and reduced distribution costs (the company operates ONE warehouse distribution center in Alabama, enabling it to ship to its regional markets quite easily) Furthermore, the company completely avoided building a multi-channel platform (selling online) throughout nearly its entire operating history, further dampening expenses, distribution costs, and marketing expenses. The company instead relied on strong brand presence and reputation, something that we will see appears to be hurting the company in present day, as the environment has changed.
Although Hibbett's past operating results have been nothing short of stellar, given how much the retail landscape has changed recently, we would assign little weight and relevance to the old competitive or strategic advantages held by the company.
These competitive advantages include:
- Wide selection of merchandise, more than competitors - the internet has the most merchandise, at the lowest prices, in the most convenient way
- Regional focus allowed them to avoid competing with big box stores - the internet made the location argument in retail completely irrelevant
- Used as the primary retailer in their markets for a full line of say, Nike sporting goods - given that HIBB store represent such a small portion of Nike overall sales, if there is a prolonged lag in inventory turns, Nike would have no problem cutting ties with Hibbett
- Superior customer service - very few care about this anymore, and in fact most people when shopping for shoes prefer to research, try on by themselves. Free/cheap return options make online even more attractive
All of the issues above lead to some large problems when trying to present an argument against the perpetual decline in the company's sales, earnings, and new store growth. We don't see an environment for Hibbett to continue to grow, or even improve their operating results, given their lack of online presence, inability to drastically cut costs, and slowing inventory turns.
Management recently spoke about reaching a 1,200-store count, as well as guiding for same store sales growth in the low-mid single digits, but quickly pulled back on those estimates in the company's most recent conference call (Q2 '18), acknowledging the tough retail environment.
We experienced a very difficult retail environment in the quarter with a significant decline in transactions and resulting in pressure on gross margins. Expenses were well controlled while maintaining proper staffing and customer service level in our stores. We expect the external environment to remain challenging, although we are encouraged with the progress we are making on our internal initiatives, most notably our new e-commerce website.
Given the company's recent poor performance and comp declines, it appears as though management finally caved, embarking on the strategic decision to build out an e-commerce site and begin to transition their business to a mix of online and offline.
Our early e-commerce sales have exceeded our expectation, and user feedback has been very positive. We will continually to - we will continue to aggressively grow our online business while continuing to improve our source to ensure a great overall customer experience.
The acquisition of new customers has just begun, and we are encouraged that with our new website and initiatives, this puts us in a new place.
While we can appreciate management's willingness to pivot, we would argue that the attempted buildout of an e-commerce business, the distribution and logistics costs associated, and the fierce levels of competition, this will actually make it harder for the company to compete moving forward. Their presence in this space is currently so small, the company has yet to even report the sales mix for online versus offline.
We can appreciate that management is saying all of the right things, but the idea of building a website to sell product in 2017 is almost laughable. The company hasn't been able to estimate a percentage of sales that will be attributed to its online business and has even talked about using their website to drive more foot traffic.
Here's an exchange between analyst David Magee and management regarding the company's sales mix:
David Magee: "Okay. Thank you, Jeff. And then secondly, the - I know it's early with the online in the e-commerce business there, what is your sense for what the purpose potential or their composition might be over time?"
Jeff Rosenthal: "Composition from amount of business in each category? Or…"
David Magee: "Well, I'm sorry, the percent of the online business that might be picked up in store, thinking that that's the more profitable. Is that a number that could be half the business eventually? Or is it just early to really assess that?"
Scott Bowman: "I think right now, David, it's a little bit too early to tell. We did take a lot of steps along the process of building this capability to make sure that our stores were tied into the e-commerce site. And so although there may be some cannibalization, there's going to be some benefit from having a website with our stores. So I think we'll see that play out. In terms of looking out, I think, I'm probably a little biased, but I think the team did an outstanding job of the look and feel of the website and some of the functionality in the content to the point where I think we're very close to our peers and maybe above some of our peers in some cases. So I think we definitely put our best foot forward. And so that being the case, there's no reason that we can't approach the penetrations we see with our peer group over time."
Jeff Rosenthal: "And I think just the online piece gives us the opportunity to drive more footsteps to our stores. With the visibility and the marketing, it also gives us visibility to our stores. For example, they might not know that we carry something in a certain store now that we have that, being able to talk to the customer more with unique visitors and increasing our acquisition of customers. I think it can help drive the business. But I agree with Scott, I believe we'll be in with where our peers are, if not greater at some point."
There are a whole host of issues that management will have to deal with moving forward, in an arena where it isn't comfortable, or hasn't had that much experience. Its cost structure may change, it will have more competition, and its 'mindshare' will start from a much lower place given its unwillingness to compete in the online space in the past.
Here's management discussing its customer acquisition strategy, and the fact that it is a relatively unknown brand in the online world:
Patrick McKeever: "Thanks very much. Jeff, you mentioned orders coming from states or areas where you don't have stores. So my question is, how are those orders coming to you online? I mean, do you have a sense of what may be driving that transaction? Is it assortment? Is it price? I mean, I would think at this juncture, your search prominence would be pretty low and that it would take some time to build that. So I mean, how do you feel you're reaching - how are you reaching that customer outside of your trade area when it's just so - you type in Nike, whatever, it's just - it's so crowded and there are a lot of others that rank higher than you on the search kickback?"
Jeff Rosenthal: "Sure. We've spent a lot of time on SEO, and we just - even before we got in here, we're pulling up certain styles and we are already on some things. We're already on Page 1, which is incredible. I would never have believed that we would be there that quickly. But we're also doing paid search. For example, if you pull up Nike Huarache, we show up on the front page or the first page. So we are very conscious of trying to acquire new customers. We will be doing more paid searches. But a lot of it - it's not about price, it's about having the best and premium product that we can have and driving them to make sure that we have a great experience. And our stores have done an excellent job of fulfilling orders, and we're fulfilling orders growth from our stores in our DC. Our stores are checking orders at least three times a day, and they're doing an excellent job on responding and getting the product out at a very quick manner. So I think we have a huge advantage, especially as many stores as we have that we can get product to customers much quicker than a lot of our competition can."
SEO? Paid search? Fast shipping? Management appears to have stepped outside of its circle of competence, forgetting that companies like Amazon, 6pm.com, and Zappos among others can deliver shoes within 1-2 days, if not hours to their customers.
Without drastically lowering costs, closing more stores, or building out a massive e-commerce infrastructure, we see nothing that is going to slow the decline of SSS and bottom line growth.
In Q2 2018, the Hibbett opened six new stores, and closed eight, representing what we believe will be the new normal for the company moving forward. As inventory turns slow, and the company is forced to use discounts and promotions, SSS continue to decline and margins become more compressed. We have arrived back at the vicious cycle of retail death.
Here are some of the highlights from the company's most recent quarter (Q2) highlighting just how bad things are becoming:
Same store sales decreased 11.7%. Gross margins were down 404 basis points. Net loss for the quarter was $5.2 million Q2 of last year. The company posted operating income of $10.1 million. Apparel sales were down double digits. Women's and kids apparel was down double digits, mens was down single digits. The license business was down double digits. Team sports business was down double digits. Footwear, the most resilient category, was down high single digits
Yikes. The decline is happening fast, and management doesn't appear to have a clear strategy to maneuver its way out of the current environment. The buildout of its e-commerce site appears to be more of a reaction to the current environment as opposed to a clear business strategy where the company sees some greenfield to acquire new customers and increase sales. We think the company will continue to post poor results, and the share price has room to fall from here.
Industry Overview
The global market for sports apparel is estimated to be around $165 billion, and growing at an annual rate of 3.8% - 4.5%. Researchers forecast the market size to grow to $184 billion by 2020.
The market for sporting goods and apparel is large, highly fragmented and extremely competitive. Large retailers of sporting goods compete for sales and market share by using a variety of store sizes, sales platforms, and marketing/promotional activities. The 'superstore' such as the current Dick's Sporting Goods or recently defunct Sports Authority, is supposed to serve as customer's one-stop shop for all things sports.
Hibbett's recent disappointing results and share price depreciation is no surprise, as the sporting goods and apparel industry seems to be undergoing massive change in terms of consumer preferences, shopping platforms, and competitive landscape.
Take these comments from recently bankrupt MC Sports CEO, Bruce Ullery:
MC Sports CEO Bruce Ullery, who owns 86% of the company, said in a court filing that "the rapid migration of sales from traditional brick-and-mortar retailers to online resellers," competing distributors, specialty retailers and "changing consumer preferences" contributed to the company's demise."
The sector endured another major disruption in 2016, when big-box chain Sports Authority liquidated. Several other notable sporting goods retailers have also filed for bankruptcy, including Eastern Outfitters and Golfsmith. Toys R Us just bit the dust, and our guess is, things are going to get much worse moving forward. Sears is hanging by a thread, and company's like Kohl's (KSS), Macy's (M), and smaller specialty retailers just can't compete against online incumbents.
In a recent USA Today article interviewing multiple retail execs and investors, the grim outlook for the retail industry, especially sporting goods was reiterated:
To some extent, the sector's problems mirror the broader retail industry's troubles. About 14% of retailers tracked by Moody's Investors Service qualified as "distressed" in February, reaching the highest point since the Great Recession.
Physical store sales for companies in the sporting goods, hobby store, book and music sector tumbled 6.9% during the 2016 holiday shopping season, while online sales jumped 19%, according to payment technology company First Data, which has a data analytics arm. Unlike online sellers, stores have to pay for often costly leases, which hampers their ability to keep prices low.
"What we found is just that the customer will come back when you offer the right discounts," said Michael McGrail, chief operating officer of Tiger Capital Group, which is jointly handling the MC Sports liquidation sales along with Great American Group. "I think their day-in, day-out shopping habits have changed and they don't come into the stores as often."
One source pointed out that sporting goods and apparel are 'at the center of the bulls-eye.'
So, in trying to outline Hibbett's competitive positioning within the industry, we came up with the following:
No pricing power, except when focusing on premium footwear where it's more a function of not having to lower prices No e-commerce presence big enough to make an impact - less than 1% of sales Not a brand name No barriers to entry - 15 year-old 'John Smith' can sell Nike products via Instagram direct to consumers No convenience, price or product differentiation - the company refuses to compete on price Not the first store one thinks of when looking for new shoes - even big box guys come first No longer small-town advantage because of the internet - who cares if you're next to Wal-Mart? If I can't go on my phone to shop for shoes with your store as the platform, you don't have any mindshare If the company disappeared tomorrow, not sure anyone would care?
Competitors
It's no secret that most brick and mortal retail companies are up against plenty of headwinds. Tougher competition, low cost merchandise, changing consumer preferences, and convenience options that they just can't offer. When it comes down to how these guys are competing, how do you beat the lowest price merchandise that can be shipped directly to a customer's doorstep?
We took a look at the recent results as well as market commentary from the management teams of Dicks Sporting Goods, Big Five Sporting Goods, Foot Locker, and Finish Line.
Things don't look good.
Big Five Sporting Goods reached pretty far into their bag of tricks after reporting second quarter results that were below expectations. CEO Steve Miller blamed the weather, the shift in calendar holidays, and high-water river flows that were responsible for closing down campgrounds, and hampering recreational activity. Not a joke.
Dick's Sporting Goods, the dominant remaining chain, is capitalizing on the fallout. It acquired dozens of stores from its bankrupt competitors, including converting 22 Sports Authority locations into its own stores. Dick's also purchased Sports Authority's intellectual property, including its website, which now redirects to Dick's.
The strategy of expanding as others contract looks like it might work. While Dick's reported a fiscal fourth-quarter decline in profit Tuesday, $90.2 million compared to $129 million for the same quarter last year, it said the reduction was based on special items. Most encouraging was that sales at stores open at least a year - a key industry measure - rose 5% and that Dick's plans to open 43 new stores this year.
Here's Dick's Chairman and CEO Ed Stack:
The retail market is currently in flux. The environment is highly competitive and dynamic. We continue to believe this disruption translates into opportunity for our business long-term. We like the position we occupy in the sporting goods marketplace. And as this industry continues to consolidate, we believe we will become stronger. Although sales and earnings did not meet our original expectations, we still reported a significant increase in our bottom line from last year of approximately 17% increase over the same period last year.
We are also targeting our marketing and pricing efforts in important regions of the country, where the fight for market share is more fierce. We've conducted extensive consumer research, and the customers have told us they feel our prices are not competitive in today's environment. Consequently, we have become more promotional and competitive, and have launched our best price guarantee where we promised the customer they find a lower price than ours, we will match it.
It's interesting to note in addition to Hibbett that some of the other big box competitors will be investing more into their online platforms. It's our view that management is admitting defeat and recognizing that in a world where every consumer is glued to their phones, this is the way to compete. Dick's e-commerce business grew 19% in Q2.
We continue to build our business on an omni-channel basis. Our project to re-launch dicks.com on a proprietary web platform has been a great success. Our digital channel is now more profitable for us on our new web platform, but we need to provide our e-commerce customers with a better experience that is competitive in today's marketplace.
Looking ahead, we are planfully investing in the online experience through faster delivery, better pricing, more targeted marketing, and continued improvements in our digital channels. This is going to be a bit more expensive in the short-term, but it is what we need to do for the long-term benefit of the company and our shareholders.
Foot Locker CEO Dick Johnson's comments on the current market environment speak volumes:
The disruption taking place today in our industry, and in retail in general, is the most significant I've seen in my quarter-century in the athletic business. The fact is that we're seeing mobile technology drive shifts in consumer behavior and spending patterns at a faster pace than our industry has been able to keep up with. With constant access to new influences, trends, information and ideas, consumers' attention spans are getting shorter, and we're seeing that they're moving from one style to the next faster than ever before.
We, and the leading suppliers in the industry are working hard to significantly shorten the product development cycle, the ordering and manufacturing lead times, the expense of supply chain and the storytelling and marketing timelines. Today, those efforts are much discussed or in practice still in their infancy, and we have a lot more progress to make.
Here's Finish Line CEO Sam Sato:
Starting with digital, as more than 70% of our customer traffic has shifted to mobile we continue to focus closely on the mobile experience. It's about speed, search optimization and a smooth checkout that will improve the customer's ability to convert. We will be rolling out enhancements, both pre and post-holiday that support our customers' expectations such as improvements to page load speed, checkout flow and cross device usability enhancements. We've also been focused on enhancing the post-purchase experience. Customers can now easily track their packages and receive notification of package delivery details including when the package has arrived at their doorstep. Later this year we will roll out an additional service feature by allowing customers to initiate a return directly from our website making it easier and faster to return an item.
Management Information
Jeffrey Rosenthal, the company's current CEO, is an experienced retail executive of over 35 years and has served as the CEO of Hibbett since 2010. Prior to that, he was the COO for one year (2009-2010), and VP of Merchandising from 1998 to 2009. Before Hibbett, he was the VP and Divisional Merchandise Manager for Champs Sports (division of Foot Locker) from 1981 to 1998.
CFO Scott Bowman was hired in 2012 from Home Depot, where he served as the Northern Division CFO since 2006. Prior to Home Depot, Bowman held various positions at companies such as Rubbermaid, Anchor Hocking and Glass, and Sherwin-Williams.
The management group has plenty of experience and has guided the company toward positive operating results, until recently. Management seems to be rational and has avoided taking on large amounts of debt, issuing shares, and seems to understand growth at a moderate pace.
Compensation and incentive structure
The company's largest shareholders are BlackRock (BLK) (13.1%), FMR LLC (12%), Arrowpoint Asset Management (11.9%) and Vanguard (8.8%).
Management owns less than 2% of the company, with CEO Jeffry Rosenthal owning less than 100,000 shares himself. We view this as strange given the CEO's tenure with the company and would prefer much more of an owner/operator type. However, management's compensation is weighted toward performance, with just 33% of CEO compensation making up his base salary. The rest is performance based.
Source: 2017 Proxy Statement
The board has set high targets for incentive compensation. Management bonuses are based on shareholder friendly, long-term cumulative EBIT targets of $345-$390m, as well as high ROIC hurdles above 15% over the last three years. That's something we can get on board with and doesn't appear to be out of line for a company generating nearly $1 billion in sales.
Compensation doesn't appear to be egregious, and to date, management has done nothing to indicate that it is not fully aligned with the shareholders of the company. The company's prudent use of debt, unwillingness to capitalize leases, and past strategic decisions (finding the right markets for new store growth, willing to cut underperforming stores quickly) indicate that this group is in it for the long term.
Management appears to be fairly compensated given the size of the company and relative to competing CEOs.
Source: 2017 Proxy Statement
Source: 2017 Proxy Statement
Debt and future obligations
The following table outlines the company's long term debt obligations:
Source: 2017 Annual Report
Capital lease obligations are found below:
Source: 2017 Annual Report
The company has no long-term debt. There are no near-term debt payments or restrictive covenants to worry about, and the company has enough of free cash flow to make rental payments, with interest payments on debt remaining minimal. The company has plenty of liquidity, with a current ratio above 3.0, and debt/equity below 0.01x.
Management appeared to make the smart choice not to capitalize leases, but as a downside measure, one has to think if the rapid decline in brick and mortar retail purchases accelerates, the company could face many more store closings at once than originally anticipated. Capital leases or not, it may be difficult to cancel existing leases for newly opened stores, or a big chunk of stores all at once. Time will tell how this plays out.
With that said, management has said it has some of the most flexible lease terms in the business (kick-out clause if projected sales aren't met), where it is able to cancel existing leases within three years should sales numbers not hit a certain target.
Nevertheless, the company has a pretty solid balance sheet, and although its equity base is declining along with the rest of the business, there is plenty of liquidity and some decent flexibility to maneuver around before Ch. 11, which we think can be a few years away.
What About Valuation?
Back in FY 2016 and early 2017, when the top line was still growing, management felt pretty good about the business operations and the launch of a new sales platform, so it guided the bottom line accordingly.
Although gross margins have remained flat over the last few years, and increases in EPS can be attributed to a decreased share count, year-end 2017 is where we can really begin to see some chinks in the armor. The company's operating income, margins and EPS declined dramatically for the first time in 5-6 years.
In Q1 2018, management guided for full year EPS of $2.35-2.55. In Q2 2018, those forecasts have since been drastically revised, with the company now expecting EPS for the full year to come in at around $1.25-1.35.
Working backwards from net income, assuming 6.0% net margins (being generous), and assuming management can get to the high end of its revised earnings guidance, that gives us net income of around $30m ($1.35 EPS x 22m TSO) for FY 2017. With the current share price around $13.40, you're looking at a P/E of 9.9, which looks cheap, but we feel has room to drop, given the company's free-falling numbers, negative net store openings, and the overall retail environment. It's also lower than competitor Dick's, which in our opinion is the stronger business, with more resources, and the ability to participate in some of the ongoing industry consolidation.
Turning our focus to free cash flow, assuming management can get to $30 million in net income for 2018 (again, being generous), adding back depreciation of $20-22 million (2.0-2.2% of sales), excluding changes in working capital since we don't yet know how the company will manage inventory, we have operating cash of $50-52 million. subtract $25-30 million in PPE for new store closures and openings, and you're left with free cash flow of around $25 million. Or a little more than $1.00/share. In our opinion, a 13x FCF multiple isn't warranted given the company's continued decline in fundamentals and the overall state of the industry.
Given the company's 50% decline in free cash flow from 2016 to 2017 and the general issues surrounding the business and the retail sector, we would assign a free cash flow multiple of no more than 5-6x, which we feel can go lower in the coming quarters.
Moving forward, management has also guided for a negative mid to high single digit same store sales and a 2.5-2.8% reduction in gross margins. We expect to see decreasing and negative guidance ranges to continue moving forward.
The company is still growing its top line, but can't seem to lower SG&A along with their decline in comps, given the cost to close unprofitable stores, and the hiring of new employees to open new stores. SG&A margins are up 160 bps over the last three years, and 130 bps YoY. We can expect increased expenses of about 80-100 bps moving forward as the company closes additional stores.
Gross margins have declined 280 basis points over the last three years, and about 48 basis points YoY, which we can expect moving forward with additional discounts, promotions, and the need to move excess inventory.
Operating margins have cratered, down nearly 50% (!) from three years ago, from 13.4% to 7.5% TTM. The company has lost 342 basis points of operating margin over the last three years.
In our opinion, these increased costs are just starting to reflect distribution and logistics expenses related to the launch of the company's e-commerce site. Both COGS and SG&A should continue to go up from here due to expenses associated with the company's omni-channel initiative.
Store labor costs may remain flat or even decrease, but they will still increase due to lower SSS. Unless the company sees a real turnaround in SSS (the entire basis for an investment thesis), costs are going to continue to go up, and sales will continue to dive. Management is smart enough to cut ties quickly with unprofitable stores, so continued store closures into the foreseeable future is more than likely. Our base case points to negative growth in all of the major categories:
Source: Author data
In addition, the company possesses no new reinvestment opportunities - new store openings are no longer growing sales - net store openings will begin to be in the negative. This is obviously a key point, given that the growth model depends on profitably opening new stores. We see ROIC declining significantly from this point on.
It appears as though management's best bet would be to buy back a ton of stock, close unprofitable stores quickly, build out logistics and distribution, translate to e-commerce, dispose of lagging product lines, focus on premium and footwear, and deal with any decline in the top line that results from these initiatives as best as it can.
Extremely unlikely scenarios include:
Liquidation - management owns less than 1% of the company, acquisition - the current retail landscape doesn't appear to have any potential buyers/partners, especially because a company like Dick's can just wait until CH. 11, or until it can buy some assets for $.30 on the dollar SSS improving in the long-term - e-commerce will prove much harder to operate than expected
Currently, shares of HIBB trade at multiples of 10.2x and 11.3x our 2018 and 2019 earnings estimates, compared to 2018 and 2019 peer averages of 10.6x and 9.3x. Our 12 to 18-month price target range of $7-9 is based on HIBB trading at 9.3x (lower end of peer average), as well as 2018 projected EPS of $0.95 (based on -2% EPS growth), and an EV/EBITDA of 4.1x our projected 2019 EBITDA of $50 million.
Source: Author data (numbers reflect prices as of 08/27/2017)
We believe these multiples are more than generous, given the company's deteriorating fundamentals, low e-commerce presence, and lack of resources to take advantage of industry consolidation. Estimates take into account potential declining share count, as management scoops up shares over the next few years in a last-ditch effort to boost EPS.
In addition, we see free cash flow declining over 50% by 2019, from $48 million TTM to the $20-25 million range, and wouldn't feel comfortable placing more than a 5-6x multiple (again, what we feel is generous) on these declining cash flows. Factoring in a reduced share count (by an average of 4% per year), would leave us with around 18.3 million shares by 2019.
Taking the high end of each estimate ($25 million free cash at a 6x multiple/18.3 million shares) gets us to a share price of around $8.00, or 35-40% lower than today's price of $13.50.
In other words, despite possible near-term pain for shorts in the event of miraculously improved SSS for one quarter, this thing is going down. It's just a matter of when.
Overall, this company doesn't check any boxes for us. It is not an off-price retailer, no premium products, not a luxury brand, no internet presence, one can get its products in other places, faster, cheaper and more conveniently. In addition, it doesn't compete on price, and it isn't participating in the industry consolidation, like competitor Dick's. If the company disappeared tomorrow, would it be a huge problem for vendors, customer's, or suppliers? We don't think so. How does SSS improve with the building out of e-commerce platform? We can't answer this.
Sure, the valuation is cheap, the company has a large net cash position, and appears to have rational management in place, yet I don't feel good about the direction of retail moving forward, or any of the other companies in the sporting goods industry. For us to win here, we would be betting on same store sales improving temporarily, in order to take advantage of a quick pop in share price, and we wouldn't be willing to hold out for that, given its low likelihood. This is the kind of company that, were the share price to decline more, we wouldn't feel comfortable starting, or adding to a position, and that tells us most of what we need to know.
Ultimately, this isn't something we would consider for the portfolio today, even with the company's depressed valuation in relative and absolute terms. We would go as far as to say the current valuation appears generous, given the macro environment and the company's continuous reporting of poor results, with no real strategic plan to stop the sales declines or closure of its under-performing stores.
We think there's still room for the share price to drop and would point to metrics such as declining free cash flow, reduced margins, declining ROIC, continued promotional activity to move inventory, and management's reduced guidance as signs that we are at the beginning of the end. Rather than focusing on the low P/E or EV/EBIT, investors need to watch the declining return on assets, total capital, and the increase in store closures moving forward. Given that there is no catalyst for improvement in our eyes, a re-rating of the shares based on the company's discount to peers seems unlikely at this stage.
It appears as though the best-case scenario for the company would be to serve as an online specialty retailer of shoes, with an e-commerce presence, but it doesn't appear that would be a profitable way to operate the business, and with that approach, you could kiss sales growth and new store openings goodbye.
Overall, there are too many questions we can't answer which leads us to an easy pass on Hibbett Sports.
Pre-mortem - a useful thought exercise
The company experiences a continued sales decline, pressure on margins, and inability to compete with cheaper, faster and more convenient online offerings.
- We have no counterpoint to this! Time to move on! The company wasn't as cheap as we thought, and there is room for this thing to drop further.
- We also don't have a counterpoint to this, as the company is trading at 5.5x EV/FCF, yet book value and FCF are both declining, despite recent share repurchases - this thing is actually going to get cheaper!
- If we were long, we would buy some more if the price declines as this represents even more value. No, we wouldn't! Same store sales haven't turned around, and I'm stuck holding $276 million in inventory.
- No counterpoint for this either, as consumer preferences could change, sales mix could decline, and vendors could stop shipping to the company if decline worsens. Management takes the company into eventual bankruptcy.
- Management owns less than 2% of the company and has a small chunk of net worth tied up into this thing - not quite there yet, but we've seen worse things happen!
- This also wouldn't be the first sporting goods apparel company to bite the dust as MC Sports and Sports Authority took the hit earlier this year
We've spent way too many hours on this, and although we've learned a lot about the current state of brick and mortar retail, it's time to move on.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
We do not short stocks, but if that was part of our strategy, Hibbett would be a good candidate.
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