It’s been about two months since I put out my bullish call on Big 5 Sporting Goods Corporation (NASDAQ:BGFV), and in that time the shares have clocked in a -4.6% return against a loss of about 4.8% for the S&P 500. In this piece I want to work out whether or not it makes sense to add to the position, hold, or sell. I’ll make that determination by looking at the “hot off the presses” financial results, and by looking at the stock as a thing distinct from the underlying business. Finally, I’m going to offer a brief update on my latest options trade here, and will shock some of my regular readers.
I know we’re all busy solving the world’s problems and watching cute baby elephant videos, and so we don’t have time to waste on superfluous verbiage. I’ll be adding to my Big 5 position today. I think the latest quarter is actually impressive if you compare it to the first 13 weeks of 2019. I think this is the most reasonable period against which to benchmark the latest results. I consider the dividend very well covered, and so Mr. Market’s 6.3% yield is a wonderful gift in my view. I wouldn’t want to insult Mr. Market by denying his gift, so I’ll take it. We’re often told that we should be greedy when others are fearful. This is a simple concept to grasp, but difficult to put into practice in the heat of the fray. I’ve had many conversations with people who lament not buying the market in March of 2009, but these people miss the point. They forget that to buy when others are fleeing the scene is actually mentally very challenging, and it’s why most people don’t do it. I think many investors will look back at the price graph of this company in five years and think “if only.” I don’t want to be one of those people, so I’m buying aggressively again. Finally, I’m not selling any more puts here today. Please contain your shock. In my view, the shares are so cheap that if you have the capital to cover a short put, you may as well put it to use in the stock.
The company just released financial statements, and before getting into my analysis of them, I thought it would be helpful to offer what I consider to be the highlights of the call:
The CEO made a statement which sounds quite reasonable to me, so I’m taking the liberty of sharing it with you.
Taking a step back for a moment, over the last couple of years, our business has achieved unprecedented growth in the face of unprecedented challenges. As some of these challenges are now beginning to recede, our earnings results continue to significantly outpace historical levels. We certainly set the bar high last year. But keep in mind that we don’t need to beat last year’s results, to produce another very profitable and successful quarter and year. We feel very optimistic about our ability to continue to capitalize on many of the recent drivers of our success including favorable product trends, expanded merchandise margins, and meaningfully reduced print advertising spend, coupled with more flexible purchasing and pricing. And perhaps more importantly, we have a highly experienced team that knows how to execute our model to drive results.
Ok, so getting into both the “nitty” and the “gritty”, the financial results here were either quite strong or quite weak, depending on your frame of reference. Relative to the first 13 weeks of 2021, the latest quarter was rather soft. In particular, revenue and net income were down by 11%, and an eye watering 57.75% respectively. While the capital structure remains quite strong, cash has dropped dramatically relative to the same time last year, while total liabilities are up a whopping $5.5 million, or 1%. On the face of it, this should give investors like me pause.
The thing is that 2021 may not have been a typical year, and thus comparisons to it may be less insightful than others. Specifically, you may recall that there was a global pandemic in the early part of this decade, and that drove sales at Big 5 well above normal. For this reason, I think my readers might be interested in benchmarking the first 13 months of 2022 (the first “post pandemic 1st quarter”) against the first 13 months of 2019 (the last “pre pandemic 1st quarter”). Since I’m absolutely obsessed with making my reader’s lives more enjoyable, that’s exactly what I’ve done.
Relative to the first 13 weeks of 2019, the first 13 weeks of 2022 were spectacular in my estimation. In particular, while revenue was basically flat (down 1.3% in 2022), net income was over 447% greater in 2022 than it was in 2019. This is because of improved margins. More impressive still is the fact that the capital structure has improved dramatically relative to the same period in 2019. Long term debt has gone from $45.4 million back then to $0 now. Back then cash represented about 1% of total liabilities, today it represents about 13%. This is a much less risky business now than it was in 2019.
I wrote in my previous missive about the sustainability of the dividend, and nothing’s happened in the meantime to change my mind on that score. If you want to understand my thinking about the dividend, I’d recommend you check out my Big 5 article before last.
As my regular readers know, I consider "the stock" to be a thing quite distinct from the underlying business. This is because the business is an organisation that sells sporting goods for a profit, and pays owners a sustainable dividend out of those profits. The stock, on the other hand, is an instrument that gets bought and sold many times a year and reflects the changing mood of the crowd. In particular, the stock price reflects the crowd's views about the distant future for the business. The mood of the crowd seems capricious, and seems incredibly fearful in my view. Given that they're governed by such different dynamics, I'm now of the view that the stock is actually a poor proxy for the health of the underlying business. This is why I treat it as a distinct entity. History has also demonstrated to me that the lower your entry price, the greater your subsequent returns, which is why I am pretty obsessive about trying to buy stock as cheaply as possible.
My regular victims know that I measure the cheapness of a stock in a few ways ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like earnings, free cash flow, book value, and the like. The more an investor pays for $1 of future economic benefit, the lower will be their returns. In my previous missive on this name, I got as excited as I ever get because the price to book ratio moved down to 1.2 times and price to sales dropped to 0.29. Things are as compelling today in my view, per the following:
At the same time that shares remain as cheaply priced as they were when I last reviewed this business, the dividend yield is near multi year highs. Paying relatively less, and getting relatively more is something I'm generally in favour of.
In addition to simple ratios, I want to try to understand what the market is currently "thinking" about the future of this company. In order to do this, I turn to the work of Professor Stephen Penman and his book "Accounting for Value." In this book, Penman walks investors through how they can apply the magic of high school algebra to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. Some people that I’ve recommended this book to “in real life” have complained that it’s a touch too academic. You can also find these insights in Mauboussin and Rappaport’s book “Expectations Investing.” Anyway, this exercise involves isolating the "g" (growth) variable in a fairly standard finance formula. Applying this approach to Big 5 at the moment suggests the market is assuming that this company will be bankrupt in about six years, which I consider to be nicely pessimistic. Given all of the above, I’m very comfortable buying shares at current prices.
In my previous missive on this name, I announced that I sold 10 of the January 2023 puts with a strike of $8 for $0.90 each. These are currently bid at $0.60, so I’m comfortable with the trade at the moment. While I normally like to try to repeat success by selling deep out of the money puts on a company I like, I think there’s little reason to do that in this instance. At a dividend yield north of 6%, the shares themselves are so compellingly priced that I’m just going to buy more of them. This is rare for me. While I really like selling puts, I can’t recommend doing so in this case. If you’ve got the risk capital necessary to sell put options, you may as well use that to collect the 6% dividend here.
I am a fan of the “Far Side” cartoon series, penned by the great Gary Larson. There was a cartoon years ago where a cat is being lured into a dryer by a dog with a misspelled sign for “cat fud”, and the thought bubble over the dog’s head reads “Oh, please! Oh, please!” I don’t want to trigger any copyright strikes, but if you google “Far Side cat fud”, you won’t be disappointed. Anyway, I’m reminded of that cartoon when I look at Big 5 shares trading in pre-market this morning. They’re down 7.5% as I type this. I feel like the dog in that cartoon, and I’m hoping that Mr. Market keeps sniffing at the door of this dryer and eventually hops in because I know that the lower my entry price, the greater my return. So, Mr. Market, do us all a favour and step into that dryer.
Update: While they’ve recovered somewhat in early trading, Mr. Market didn’t disappoint, and is now offering these shares at a dividend yield of ~6.3%. I consider this dividend to be sustainable, and therefore I will be buying more this morning. I think the recent financial results were quite good when compared to a reasonable benchmark, and I love the market’s overreaction. Also, while I don’t normally look at such things, I really like the 41% short interest here because there's a chance a short squeeze would give the shares a nice bounce from here.
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Disclosure: I/we have a beneficial long position in the shares of BGFV either through stock ownership, options, or other derivatives. 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.
Additional disclosure: In addition to my short puts and stock, I've just bought another 800 shares this morning.