By Valuentum Analysts.
At Valuentum, we use discounted cash-flow (DCF) analysis as the bedrock of our process. However, we also use relative valuation and technical and momentum indicators and blend that into an output called the Valuentum Buying Index rating, or the VBI rating. We like to help members sort ideas in a systematic fashion so they can apply our work in any way that they would like.
As shown in the flow chart below, we'll show how DICK'S Sporting Goods, Inc. (NYSE:DKS) registers a 7 on the VBI, as it garners an undervalued perspective on our DCF process, a neutral view from a relative valuation basis, and bullish technical assessment. A pretty neat, process, with so much embedded in one number, no? Let us know in the comments below.
Let's now talk DICK's Sporting Goods, in particular. DICK's Sporting Goods is a full-line sporting goods retailer offering a broad assortment of brand name sporting goods equipment, apparel, and footwear. The company also owns and operates Golf Galaxy, a golf specialty retailer, and Field & Stream, a hunting and fishing specialty retailer. The firm was founded in 1948, and it has flourished since then.
DICK's Sporting Goods has an industry-leading omnichannel platform that serves athletes through in-store and online (curbside and home delivery) shopping options. The retailer continues to work on building brand loyalty and a seamless shopping experience.
The company's e-commerce business has been a source of strength in recent fiscal years. In November 2021, the retailer announced a strategic partnership with Nike that involves both physical and digital platforms. DICK's Sporting Goods is rolling out new store concepts such as DICK's House of Sport and Public Lands.
Athletes go to DICK's Sporting Goods to buy some of the top brands, including Adidas (OTCQX:ADDYY, OTCQX:ADDDF), Callaway (MODG), Columbia (COLM), Nike (NKE), The North Face, Titleist, Under Armour (UA), and Yeti (YETI), among others. It also has a number of private label offerings not available elsewhere such as Second Skin, DSG, and Top-Flite.
Though DICK's Sporting Goods is succeeding in both e-commerce and brick-and-mortar, the retail sporting goods market is a tough one. For example, The Sports Authority and Gander Mountain both filed for Chapter 11 bankruptcy protection in recent years.
On August 23, DICK's Sporting Goods Inc reported second quarter earnings for fiscal 2022 (period ended July 30, 2022) that beat both consensus top- and bottom-line estimates. The sporting goods retailer also raised its full-year guidance for fiscal 2022 in conjunction with the report, after previously lowering its guidance during its fiscal first quarter earnings update in May 2022.
In the second quarter of fiscal 2022, DICK's Sporting Goods reported that its comparable store sales dropped by 5.1% (after growing by 20.2% in the same period the previous fiscal year). Please note that DICK's Sporting Goods' performance is "normalizing" after the banner performance put up in fiscal 2020 (comparable store sales were up 9.9%) and fiscal 2021 (comparable store sales were up 26.5%). Management noted that "transactions declined 8.4% while the average ticket increased 3.3%" last fiscal quarter during the company's latest earnings call and that "each of our 3 primary categories of hardlines, apparel and footwear performed generally in line with our expectations."
The decline in the firm's comparable store sales dragged its GAAP net sales down by 5% year-over-year last fiscal quarter to reach $3.1 billion. However, DICK's Sporting Goods noted that its net sales were still up 38% versus its performance in the second quarter of fiscal 2019 when it generated $2.3 billion in GAAP net sales. Comparing its recent performance to its performance in fiscal 2019 is meaningful, as that is the fiscal year before COVID hit the US economy, which prompted a major shift in consumer spending habits.
Last fiscal quarter, the company's GAAP gross margin dropped by ~390 basis points year-over-year, hitting just over 36.0%. In the second quarter of fiscal 2019, its GAAP gross margin stood near 29.0%. The reason that, when looking at its performance over a longer time horizon, DICK's Sporting Goods' gross margins have been trending in the right direction is in part due a growing portion of its digital sales being fulfilled via its physical stores. Management noted that "our stores enabled over 90% of our total sales, serving both our in-store athletes and providing over 800 forward points of distribution for omnichannel fulfillment" in the fiscal second quarter during the retailer's latest earnings call.
DICK's Sporting Goods' GAAP operating margin stood at 14.8% in the fiscal second quarter, down ~545 basis points year-over-year, due to headwinds facing its gross margins along with rising operating expenses. However, its GAAP operating margin last fiscal quarter was more than double what it was in the second quarter of fiscal 2019 (it stood just below 6.9% during that period). The decline in its operating margin saw DICK's Sporting Goods' GAAP operating income drop by 31% year-over-year to hit $0.5 billion last fiscal quarter.
Again, after a banner performance in fiscal 2020-2021, a normalization in its performance is to be expected. The company's GAAP diluted EPS stood at $3.25 (down 28% year-over-year) and its non-GAAP diluted EPS stood at $3.68 (also down 28% year-over-year) in the second quarter of fiscal 2022.
The retailer's net operating cash flows were held down by a large working capital build during the first half of fiscal 2022 (resulting in negative free cash flow during this period), though historically, DICK's Sporting Goods has been a stellar free cash flow generator. Its free cash flows averaged ~$0.9 billion from fiscal 2019-2021. DICK's Sporting Goods spent $0.1 billion covering its dividend obligations and another $0.4 billion buying back its stock during the first half of fiscal 2022.
As of July 30, 2022, the firm had $1.9 billion in cash and cash equivalents on hand with no short-term debt and $1.9 billion in long-term debt on the books, good for a marginal net cash position. We are huge fans of DICK's Sporting Goods' financial strength. The retailer also had sizable operating lease liabilities on the books at the end of this period to be aware of. The company exited July 30 with ample inventory on hand to meet consumer needs. Management noted in DICK's Sporting Goods' latest earnings press release that "our inventory is healthy and well-positioned, and we are excited about our assortment for the back-to-school season" which in part underpins the firm's recent guidance boost.
The best measure of a company's ability to create value for shareholders is expressed by comparing its return on invested capital [ROIC] with its weighted average cost of capital [WACC]. The gap or difference between ROIC and WACC is called the firm's economic profit spread. DICK's Sporting's 3-year historical return on invested capital (without goodwill) is 72.3%, which is above the estimate of its cost of capital of 9%.
As such, we assign the firm a ValueCreation rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
We think DICK's Sporting is worth $138 per share with a fair value range of $106-$170. Shares are trading at ~$108 at the time of this writing. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk rating, which is derived from an evaluation of the historical volatility of key valuation drivers and a future assessment of them. We'll talk more about this later.
During its fiscal first quarter earnings update in May 2022, DICK's Sporting Goods reduced its forecasted comparable store sales performance (versus expectations laid out in March 2022) by increasing its expected decline on this front while also reducing its forecasted GAAP and non-GAAP diluted EPS for fiscal 2022.
However, DICK's Sporting Goods increased its GAAP diluted EPS forecast to $8.85-$10.55 (versus $7.95-$10.15 previously) and non-GAAP diluted EPS forecast to $10.00-$12.00 (versus $9.15-$11.70 previously) for fiscal 2022 during its latest earnings update as it updated its forecasted comparable store sales performance to a decline of 2% to 6% versus a decline of 2% to 8% previously.
The company maintained its capital expenditure guidance of $400-$425 million in fiscal 2022, a forecast that DICK's Sporting Goods issued out in March 2022. In our view, DICK's Sporting Goods' efforts to rollout new store formats and store concepts along with its digital and customer loyalty initiatives is helping mitigate the worst of the near term headwinds facing the retailer and the US consumer, with an eye towards inflationary pressures (rising fuel prices pressuring consumer spending power) and supply chain hurdles (difficulties managing inventory levels).
Some of DICK's Sporting Goods' growth efforts include rolling out new store concepts such as its DICK's House of Sport and Public Lands stores. The former includes turf fields, rock climbing walls, batting cages, putting greens, golf hitting bays, and places to do yoga along with providing an expansive slate of sport equipment and related services for consumers to purchase. The latter is focused on selling outdoors equipment and related products (from bikes to athleisure wear), and also includes a rock wall component along with the ability to sell related services and offer specialized shopping centers for biking, hiking, fishing, camping, and other outdoor activities.
We appreciate the company's focus on innovation and its efforts are steadily paying off. On a final note, DICK's Sporting Goods' unit store count has grown from 727 as of August 3, 2019, to over 850 stores (across all of its store concepts) according to its latest earnings press release published August 23, 2022. The retailer's store unit count will likely continue to grow at a robust pace going forward and we see ample room for upside on this front.
Our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 1.6% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 13.4%. Our valuation model reflects a 5-year projected average operating margin of 12.1%, which is above DICK's Sporting's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 3.1% for the next 15 years and 3% in perpetuity. For DICK's Sporting, we use a 9% weighted average cost of capital to discount future free cash flows, which we think is reasonable.
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate DICK's Sporting Goods' fair value at about $138 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
Our ValueRisk rating sets the margin of safety or the fair value range we assign to each stock. In the graph above, we show this probable range of fair values for DICK's Sporting. We think the firm is attractive below $106 per share (the green line), but quite expensive above $170 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
DICK's Sporting Goods' e-commerce sales have soared higher over the past few years and the company continues to support its private label brands. The firm is a tremendous generator of free cash flow and has a pristine balance sheet. Its omni-channel success has enabled DICK's Sporting Goods to keep its asset base relevant in the digital age. The retailer's customer loyalty program has also proven to be quite effective at supporting its sales performance. We expect that DICK's Sporting Goods will continue to grow its dividend at a robust pace going forward. In 2012, the company paid a special dividend of $2 per share and in 2021, a special dividend of $5.50 per share.
Investors must remember that no matter how strong DICK's Sporting Goods' recent growth has been, it is not immune to challenges of the current retail environment. The retailer has shown its dividend some love in recent years, but the company's share buyback program competes for capital against its dividend program. We are not expecting payout growth at DICK's Sporting Goods to slow anytime soon given its strong Dividend Cushion ratio, a product of its impressive free cash flow generating abilities, pristine balance sheet, and promising growth outlook. The company is rolling out new specialty store formats, and its focus on innovation is commendable. Our fair value estimate for DICK'S Sporting Goods, Inc. stands considerably above its last trading price.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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: Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson's household owns shares in HON, DIS, HAS, NKE, and RSP. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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