Big 5 Sporting Goods: Looking For Sustainable Earnings Level
Summary
- Big 5 Sporting Goods has struggled to generate a healthy margin and has seen a decline in stock price over the past as a result.
- The company's revenues have decreased in recent quarters due to a slowdown after a pandemic-boosted sales level and macroeconomic issues.
- Big 5 seems to be priced for the mentioned issues, with a DCF model pointing towards a fairly valued stock - I have a hold-rating for the time being.
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Big 5 Sporting Goods (NASDAQ:BGFV) sells sporting goods in the United States. The company's financials have seen their fair share of turbulence, as the company struggles to generate a healthy margin. I believe the issues are priced into the stock, though; I have a hold-rating for the stock for the time being.
The Company
Big 5 Sporting Goods sells merchandise, accessories, shoes, and apparel related to sports. The company sells other companies' products as well as the company's own private label brands such as Golden Bear, Harsh, and Pacifica.
The company's stock has had a turbulent history - the stock has fallen 52% in price over the past ten years, with a significant jump in 2020 and 2021 as the pandemic temporarily boosted Big 5's earnings massively:
10-Year Stock Chart (Seeking Alpha)
Big 5 currently has a massive dividend yield of almost 14%. The dividend doesn't seem to be safe, though - Big 5's cash flows are currently significantly too low to maintain such a dividend, as the payout ratio is estimated at 270%.
Financials
Big 5 hasn't had a large amount of growth in its history - from 2002 to 2022, the company has achieved a compounded annual growth rate of 2.0%, translating to basically no growth in real terms:
Author's Calculation Using TIKR Data
After a pandemic-boosted 2021, Big 5's revenues have started to decrease - from Q3 of 2021 to the most recent quarter, Q2/2023, the company's revenues have decreased in every quarter, resulting in a currently trailing revenue amount of $948 million, around 5% below 2019's level despite the high inflation - in the company's most recent earnings call, CEO Steve Miller contributed the slow sales to a weak macroeconomic sentiment and poor weather:
"As we anticipated, macroeconomic headwinds continue to impact consumer discretionary spending throughout the second quarter. However, we did not anticipate the unseasonably cool weather conditions that we experienced over the back half of the quarter, particularly in our core California market. The slow start to summer had a significant impact on our sales, which came in slightly below expectations."
The attribution makes sense - I don't see a reason as to why revenues should be below 2019's level. I believe that revenues should jump back into a more healthy level in the medium term, although the second half of the year could also be difficult. Miller pointed out that as of the first of August, third quarter sales trends have increased significantly.
The current issues aren't only Big 5's own creation - for example, DICK'S lowered its guidance in August related to a slowdown in the outdoor category as well as a rising level of theft.
Big 5 has had a poor performance in the company's margin - Big 5's EBIT margin has decreased significantly in the long-term. From 2002 to 2022 the company's margin has been around 4.6% on average, with the trailing figure standing at 1.1% - Big 5 needs to scale its margin back up with increased sales. If revenues jump back as I anticipate in the medium term, I believe the company could achieve a margin that is at least significantly closer to the long-term average.
Author's Calculation Using TIKR Data
As earnings have fluctuated significantly, I believe it's good that Big 5 currently has no interest-bearing debt. The company does operate with a low amount of cash though - after Q2, Big 5 has around $6 million in cash.
Valuation
As usual, I constructed a discounted cash flow model to demonstrate the valuation. In the model, I estimate revenues to decrease by 5% in 2023. With the first half's revenues decreasing by 9.5%, the estimate would imply a better second half for the company, but I believe the company is already facing very soft comparison numbers in the second half of the year. After 2023, I estimate a growth of 5% for 2024 as the market conditions normalize. The growth slows down into 2% in 2026 and forward.
I estimate Big 5's margin to only be 0.5% for the current year due to temporary issues. Going forward, I estimate the company's margin to reach 2.8% - the margin would still be significantly below the long-term average of 4.6%, but I don't see it as likely that such a margin can be achieved. These estimates along with a cost of capital of 14.59% craft the following DCF model with a fair value estimate of $7.57, around 4% above the current price:
DCF Model (Author's Calculation)
The used weighed average cost of capital is derived from a capital asset pricing model:
CAPM (Author's Calculation)
Understandably, Big 5 doesn't currently leverage interest-bearing debt as the company's earnings level is very low. I estimate that as the company's earnings slightly improve, the company draws a small amount of debt, represented by the 5% long-term debt-to-equity ratio. I estimate the company's interest rate for the debt to be 6% - I believe this leaves a healthy margin, as the United States' 10-year bond yield stands at 4.34%.
I use the mentioned 10-year bond yield as the risk-free rate. The estimated equity risk premium of 5.91% is Professor Aswath Damodaran's approximate made in July.
As for Big 5's beta, Tikr estimates a figure of 2.79. I believe the figure to be higher than the company should have in the long-term, as the current issues have increased earnings volatility. In comparison, DICK'S Sporting Goods has a beta of 1.46, and Sportsman's Warehouse has a beta of 0.97. I believe an average of these three gives a more accurate figure of Big 5's beta in the long-term as my DCF model estimates a better future for the company - I use a beta of 1.74 in the model, the average of the three mentioned stocks.
Finally, I add a liquidity premium of 0.5% into the cost of equity, crafting the cost of equity into 15.12% and the WACC to 14.59%.
Takeaway
Big 5 has undeniably had a turbulent history, as the company has struggled to keep up a good operating margin. The company is facing a significant risk to a dividend cut, as the current earnings level does not provide a sustainable basis for the current dividend. I believe that Big 5's earnings should rise significantly as the macroeconomic situation becomes better, though - the company is at an interesting point. At the current price, I believe Big 5's stock correctly reflects the company's sustainable earnings level, leading to a hold-rating.
This article was written by
Analyst’s 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.
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