- Academy Sports and Outdoors remains a deep value opportunity.
- ASO has repeatedly beat on earnings and has very good free cash-flow relative to its market cap.
- The e-commerce business and omnichannel strategy is still maturing with an opportunity for the company to improve profitability.
- ASO has rewarded shareholders with a significant buyback program and dividend payments may not be far off.
- Management is managing capital conservatively with a primary focus on the balance sheet and growing strategically.
Academy Sports and Outdoors (NASDAQ:ASO) is a relatively new public company, but has a long history dating back to its founding in 1938 as a family business in Texas. With retail locations in 16 states from the Midwest to the Southeast, Academy is still in the early innings of fully developing its e-commerce business and competing at a much larger scale.
Academy Sports still trails its sector and most notable peer, DICK'S Sporting Goods (DKS), in valuation and the gap should only close further as Academy grows its e-commerce business in particular.
In its short time as a public company, Academy has only beat on earnings every quarter and raised guidance for 2021 after reporting Q2 earnings. I am anticipating another strong quarter with the return to team sports in the fall, the beginning of hunting season, and the added benefit from the launch of their mobile app in July 2021.
With net income growth of 67% year-over-year in Q2 and a share repurchase program of $500M, Academy Sports is in a strong position to continue rewarding shareholders in the form of buybacks and the possibility of a dividend in the not too distance future.
I am bullish on ASO and will discuss why I believe that the stock is poised to make another leg up post Q3 earnings.
E-Commerce and Accelerating Growth
It is important to recognize that ASO is still in the early phases of implementing its omnichannel strategy and has already seen remarkable growth in e-commerce sales compared to pre-pandemic levels in 2019.
(Source: ASO Q2 Earnings Presentation)
E-Commerce sales penetration was only 8.4% in Q2 which is a testament to the strong relationships they still maintain with customers who prefer to shop in store, but also represents the large upside in sales growth ahead.
Total sales growth for the company was at 44.8% for Q2 2021 as compared to Q2 2019, but e-commerce sales grew by 207% comparatively. This rate of growth will slow some as the business matures, but CEO Ken Hicks stated in the earnings call transcript that ASO will continue to invest in the omnichannel field and we continue to work to improve their operations.
I don't think there's another retailer that has the omnichannel, the organic, the operational, and new store growth opportunities that we have.
(Source: CEO Ken Hicks from the Q2 Earnings Call Transcript)
My interpretation of that statement is that there is still plenty of room for improvement and growth, but the foundation is in place and there is a clear strategic path for ASO to build on.
Ken Hicks would also emphasize that the omnichannel business is not yet as profitable as the stores, but is quickly approaching that level. They are also supporting the omnichannel business by adding payment capabilities, introducing their mobile app, improving communications with online customers, and working to make the customer experience more seamless between the stores and omnichannel.
So, we still have a lot of work left. We were late to the game in omnichannel, and we will look to the customers to decide how big it should be. We haven't said it's got to be this percentage, but I would envision omnichannel is probably going to be over the next year or two of 15%, 20% of our business. And the penetration will continue to grow.
(Source: CEO Ken Hicks from the Q2 Earnings Call Transcript)
Deployment of Capital
Beyond using excess capital to strengthen the omnichannel business, ASO is also looking to open 8 to 10 new stores in the coming year. This would represent roughly 4% growth over the current store count of 259.
ASO has traditionally used a 60,000 square foot store that they believe maximizes sales per sf and profitability per sf. However, they are beginning to experiment with a smaller 40,000 sf model with the opening of their 24th location in the Dallas-Ft. Worth market. This smaller store is less profitable than the larger store, per ASO's earnings call, but will allow them to grow their footprint faster and strengthen existing markets utilizing infill locations that otherwise would not be able to support the larger store.
ASO is fulfilling 75% of e-commerce sales from the stores so new stores will only help grow the omnichannel business. This is similar to the strategy that big box retailers, such as Target (TGT), have used successfully and in Target's case, is 90% more cost effective than shipping from warehouses.
The best way to grow our omnichannel is to grow our fleet, because 75% of our e-commerce businesses is fulfilled from the store. We're only in 16 states that leaves, 30 plus states that have a chance to experience the Academy magic as we look to grow and bring our winning model outside of our current footprint.
(Source: Michael Mullican from the Q2 Earnings Call Transcript)
Michael Mullican would go on later in the call to highlight the fact that they currently have the capacity to add up to 100 stores without having to expand their distribution networks and it only costs ASO $3M to build a store. The only limiting factor to growth is the organizational capability that ASO is focused on building on the back end. This is an incredible growth prospect considering they could increase store count by nearly 40% just from their free cash-flow.
In addition to the $500M share buyback program announced after Q2 earnings, the company purchased and retired 3.2 million shares for $100M in a transaction with their largest shareholder, KKR. They also paid down $99M of its outstanding term loan and refinanced the interest rate from LIBOR + 5.0% to LIBOR + 3.75%.
(Source: ASO Q2 Earnings Press Release)
This is exactly what you want to see the company doing with their strong cash position. Total interest expenses have been reduced by 1% of sales year-over-year and long-term debt now stands at $684M. While there were no specifics offered on further payments against the debt, it can be expected that they will continue pay down debt and could be within two years of being debt free. This is something I will be watching closely in future earnings reports as improvements to free cash flow will be a boon to shareholders.
Dividend Payments on the Horizon
CEO Ken Hicks was asked on the Q2 earnings call about the potential to begin paying dividends within the next year. His response was brief, but he did not reject the possibility.
We will continue to explore what we think is best for the company and for our investors. Right now, given where the stock quite frankly is valued, a buyback makes the most sense, and we will evaluate all the options to make sure that we are giving their shareholders the adequate return.
(Source: Ken Hicks from the Q2 Earnings Transcript)
ASO stock is currently trading in a similar range to where it was at the time of the Q2 report so I anticipate that we will at least see management continue with a share buyback strategy in the near term. However, should the valuation rise to be in line with their industry peers, we may very well see a quarterly dividend payment put in place.
Using DICK'S Sporting Goods (DKS) as a barometer, they currently have a dividend yield of 1.53% with a payout ratio of 11.76%. ASO has a forward EPS of $6.35 so at the same payout ratio of DKS, we could see an annual dividend payment from ASO of $0.75/share with a yield on cost of 1.74% at the current price per share.
ASO showed strong growth in net income and EPS in Q2 and raised guidance for 2021 to $5.45-5.80.
(Source: Q2 Earnings Presentation)
As I mentioned previously, ASO continues to reduce leverage and is buying back a significant number of outstanding shares. With Margins now at 35.9%, additional improvement in margins will become minimal. However, EPS could improve by up to 53 basis points with the extinguishment of the debt in the coming years.
ASO has grown their cash position from the beginning of 2021. I will be looking at the Q3 report to see the impact from the $500M stock buyback program and believe we may see an additional payment towards their debt. Regardless, there is plenty of cash on hand to execute their growth strategy and I do not foresee any further share offerings with the stock value continuing to be undervalued in the eyes of management.
I believe that forward EPS estimates continue to be undervalued by analysts.
(Source: Seeking Alpha)
Yes, growth rates will slow as the initial benefits to their e-commerce business and consumer habits due to COVID burn off. However, the company has done nothing but continue to beat earnings estimates each quarter and raise guidance. At some point the "smart money" has to recognize that they are not just getting lucky and actually executing at a high level.
We are looking at a company that has guided to net sales of $6.5 billion in 2021, free cash-flow of over $500M, and only has a market cap of $4 billion.
Prior to the COVID pandemic this was an industry with P/E ratios in the mid-teens. DKS has a 5Y avg. P/E (FWD) of 16.82, but currently stands at 8.21. Assuming consumer sentiment stays strong, supply chain issues subside, and inflation stabilizes in the next year, I would argue that P/E multiples should rise for a company like ASO.
ASO is ultimately a deep value play with strong growth prospects in an investment environment that is underappreciating this unique combination.
Challenges to the Thesis
ASO does offer higher value goods with a premium consumer in mind, but it still has to be ever cognizant of pricing and product availability as it continues to expand its geographical footprint. As such, they will need to build out the expertise and inventory for regional specific goods, such as snow sports in the Mountain West or fishing gear better suited for Florida vs the gulf coast of Texas.
The company is just beginning to experiment with a smaller store model and it is yet to be proven that this will be a good use of capital and operational capacity. There will also be further capital outlays to re-model older stores and bring them more in line with their omnichannel strategy.
Even with the stores functioning as mini fulfillment centers, they are still expensive real estate to lease in an environment that continues to shift towards e-commerce. ASO will be challenged to continue to strengthen their strong brand value with customers and find the right balance between in-store shopping, pick-up, and delivery.
Lastly, brand recognition is limited outside of the Southeastern states and investors should anticipate promotional and marketing expenses to rise as ASO expands into new markets.
Academy cannot be overlooked as a great value play with significant growth prospects and the ability to reward investors with buybacks and dividends in the immediate future. The company has a clear path to expand earnings and management continues to show a high level of execution.
I am currently a bull heading into the Q3 Earnings Report and believe the stock continues to be undervalued based on a strong cash-flow position and limited headwinds to the business model. Investors looking for long-term growth and a moderate risk profile should look into building or expanding a position in ASO.
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