Hibbett Sports: Thesis, Results, & Outlook

Summary

• Hibbett is a well-run corporation with attractive financials and a unique business model.
• The purchase of City Gear is expected to boost the top and bottom lines.
• A senior management transition is underway.
• Latest quarterly and full year results were strong.
• FY2020 outlookappears positive.

Introduction:

Hibbett (NASDAQ:HIBB) is a sporting goods retailer that focuses on footwear, sports apparel, and equipment. These segments accounted for 57.5%, 27.4%, and 15.1% of sales respectively in the last fiscal year. The organization’s stores are mainly located at strip malls anchored by tenants such as Walmart, in small and mid-sized communities. Geographically, its stores cover 35 states but are mainly concentrated in Texas, Georgia, Alabama, and Tennessee. Publicly traded peers include Dick's Sporting Goods (NYSE:DKS), Foot Locker (NYSE:FL), Genesco (NYSE:GCO), Shoe Carnival (NASDAQ:SCVL), and Big 5 Sporting Goods (NASDAQ:BGFV), as well as online competitors, including Amazon.

In today’s relatively overvalued market, retail is one of the industries where we continue to find many beaten up stocks. For new readers, or those who may have missed it, I wrote about downtrodden sectors in more detail in another recent article, Searching For A Bargain. Here at Contra the Heard Investment Newsletter, we have been watching the retail space for a few years, and keeping an eye on Hibbett in particular. In December, HIBB was purchased for the Vice-President’s Portfolio at $15.01. At the time, the market was under pressure, tax loss selling was in full swing, and the shares were getting hammered. This meant the valuations at the time were low on a variety of metrics, including price to sales, book value, earnings, cash flow, EV/sales, and EV/EBITDA. Since then the enterprise has rallied but is still considered a buy at under $20.00.

Hibbett’s Investment Thesis:

Hibbett initially attracted our interest years ago because of its balance sheet. Though a balance sheet is not the be-all and end-all, looking for robust financials is often a good starting point. In the latest quarter, the venture boasted a net cash position, low goodwill, and nominal debt despite the recent acquisition of privately held peer City Gear; current assets exceed all liabilities too. Hibbett is what Charlie Munger would call a “cannibal” as it frequently buys back large amounts of its own stock. Since 2009, the outstanding share count has fallen from 29 million to under 19 million. Purchasing one’s own stock can destroy capital just like other activities, if the valuations are rich or the projected returns fizzle, but in this case, officers don’t appear to have sinned at the buyback altar. We would like to see large but infrequent buybacks continue in the future, assuming valuations are low.

Investigating further, we see that the retailer is growing its top line, that same store sales are up, and that it has maintained profitability despite intense competition and shifts within the retail space. Part of the reason for Hibbett’s growth and positive bottom line is their atypical business model. Instead of attempting to compete in all markets, they operate in under-served small and mid-sized communities. Another related prong of this strategy is that the company targets store locations in existing strip malls that are already anchored by a large tenant like Walmart. Being located at centres anchored by reliable tenants like Walmart helps drive traffic and allows smaller retailers to ride the coattails of the bigger player. Hibbett also operates primarily in states with relatively low minimum wages and union participation, which can reduce some staffing related issues. Despite this potentially lower employee protection, approval and satisfaction among employees is decent, at least according to third party providers like Glassdoor.

The executives have also taken a unique approach to merchandise. Instead of trying to compete in all product segments, Hibbett specializes in footwear. While the company does sell sports apparel and equipment, shoes are its bread and butter. This has allowed Hibbett to brand itself as something of a shoe-selling specialist. The firm is adapting to the new online and omni-channel environment too. It was relatively late to the web and only launched an online platform 18 months ago, but in that time, e-commerce has reached $100 million and accounted for 10.6% of revenue in the latest quarter. That is outstanding.

Risks to the Thesis:

Though Hibbett’s strategy is unique, it is not without consequence, and the industry itself is not without risks. On the macro side, while the e-commerce platform has performed well, consumers’ shifting preferences to online shopping can swamp smaller companies like this one, and going forward the e-commerce shift may morph the competitive landscape in unanticipated ways.

Furthermore, the focus on footwear over sports apparel and equipment means that their inventory is overly dependent on Nike (NYSE:NKE) when compared to their other large suppliers (which include Under Armor and ADIDAS). In the prior year, Nike’s portion of inventory purchases was 65.4%. While Hibbett appears to have a good relationship with Nike, as one of their top five key accounts in the US, Nike likely holds more bargaining and pricing power in this relationship. It also has retail locations of its own that compete directly with Hibbett, making Nike something of a frenemy.

Hibbett has grown its top line and maintained profitability, but its margins have suffered in the wake of industry shifts and the move to online. In response, stores have been closed, and late last year a smaller rival, City Gear, was purchased for $88 million. The hope is that this M&A will accelerate growth and improve margins. Prior to being acquired, City Gear operated 135 stores in 35 states, generated approximately $190 million in annual sales, and had a similar focus on footwear, apparel, and equipment. In our opinion, the strategic fit looks rational but HIBB did have to pay up for it. Though the City Gear integration seems to be going well so far, it’s still in its early days.

Another potential risk that has entered the field since HIBB was purchased here at Contra the Heard can be found in recent changes to the executive team. The CFO, Scott Bowman, is leaving to pursue other opportunities and be closer to family. CEO Jeffry Rosenthal is retiring too. Jeffry has been the CEO for nine years. He started working in the industry selling shoes for $5.00 an hour and has now been with Hibbett for 21 years. He will stay on the board after his replacement is hired. On the call, Jeffry was asked about a timeline, and answered with an estimate of at least six to eight months, if not longer. He stressed that he and the board want to get the transition right, and that he wants to remain heavily involved as a director. The CFO’s departure appears to be within the realm of standard turn-over, and the CEO’s transition roadmap looks like solid and well-thought-out succession planning. Still, we’ve been fooled by management changes in the past, and it will be a long time before one will be able to say if the transition is a success.

Latest Quarterly & Full Year Results:

The latest quarterly and full year results were encouraging. HIBB’s annual top line exceeded one billion for the first time in the organization’s history. Earnings per share surpassed estimates and same store sales grew 2.2%. As mentioned above, online transactions accounted for 10.6% of revenue and grew 60% in the fourth quarter. The online segment was also profitable in the quarter. This is especially impressive given that Hibbett didn’t have an online presence until mid-2017. The income statement performance, online growth, and initial progress on City Gear may explain why the ticker jumped 20% the day of the earnings release while US benchmarks were down 2%.

Annual Outlook & Strategy:

In FY2020, City Gear should boost revenues, but comparable store sales are projected be flat. Earnings per share is expected to be between $1.50 and $1.70 (including $0.25 to $0.35 in non-recurring City Gear costs) versus $1.51 earnings per share in the latest year. The buyback will remain in place next year too but at a reduced pace relative to the $16.5 million spent on repurchases last year.

Instead of prioritizing the buyback, staff will work on the integration of City Gear. In tandem with this effort, the combined entity will be rationalizing its store base. Top brass expects to close 95 stores and open 10 to 15 in the coming year, versus 84 store closures and 32 openings in the prior year. Many of these closures will take place in smaller towns with stores that sell predominately sporting good merchandise as opposed to footwear and athletic specialty gear. The team will also work on expanding online sales and their omni-channel capabilities. In the years ahead, it is possible that e-commerce margins may match brick and mortar margins, and potentially exceed them.

Conclusion:

Hibbett Sports is a well-run organization with solid financials and a unique business model. The company is growing its online and omni-channel capabilities and is rationalizing its store footprint to adapt to the changing competitive landscape. The recent City Gear acquisition may reward shareholders in time, but for now it’s still too soon to tell. The CEO and CFO transitions are other potential risks, though the CEO’s succession strategy looks well planned. While it was purchased here at Contra the Heard in December at $15.01, it has rallied since then. That said, valuations seem reasonable and the stock remains on our buy list for subscribers at under $20.00. In the months ahead we will watch closely to see how the management and City Gear changes unfold.

Disclaimer:

The opinions expressed – imperfect and often subject to change – are not intended nor should be taken as advice or guidance. Contra the Heard Investment Newsletter is not an investment advisor or financial advisor. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long HIBB. 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.