Dick's Increasing Dependence On E-Commerce May Spell Trouble

| About: Dick's Sporting (DKS)
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Shares of Dick's (NYSE:DKS) Sporting Goods have performed well this year, rising nearly 30% from around $37 at the beginning of January to around $48 currently. The company reported a strong first quarter, and every analyst who covers the stock has it at 'hold' or better. Additionally, the company is expected to earn $2.51 per share this year, meaning it trades at a very reasonable price-to-earnings ratio.

However, the company may be relying more on e-commerce than many investors realize, a problem, given Amazon's move into the segment. One particularly worrisome statement in the company's 2011 10-K relates to same store sales. Dick's notes that in

"Fiscal 2011 consolidated same store sales increased 2.0% compared to a 7.2% increase in fiscal 2010. The Company believes that its ability to consistently deliver increases in consolidated same store sales will be a key factor in achieving its targeted levels of earnings per share growth and continuing its store expansion program."

So same store sales growth is critical, and it fell by 73% in 2011 from 2010. A closer examination of the company's same store sales calculations reveals another interesting fact: beginning in 2010, Dick's began factoring in it's e-commerce business when calculating same store sales. The impact of this inclusion was 73 basis points in fiscal 2010, meaning same store sales at the company's physical stores grew 6.47% during the year, which is no too bad. However, during the fiscal year 2011, the 36.4% increase in e-commerce business contributed 100 basis points to the company's same store sales increase of 2%, meaning that, by my reading, gains in e-commerce went from accounting for 10% of same store sales growth in 2010 to 50% of same store sales growth in 2011. Translation: not as many people are going to the stores. Providing further support for this contention is the following statement:

The same store sales increase at Dick's stores was driven by an increase in sales per transaction of approximately 2.4%, offset by a decrease in transactions of approximately 1.6% at Dick's stores

Transactions are down 1.6% at the company's physical stores, a far cry from the 6.5% increase in transactions the company realized in fiscal 2010.

Mercifully, this trend reversed itself during the first quarter as the company's 10-Q shows same store sales rising 8.4% during the quarter ended April 28, with only 63 basis points attributable to a rise in e-commerce. Additionally, transactions rose 3.3% at Dick's physical stores. While this is indeed encouraging, it is only one quarter. If Dick's fiscal year results continue to show an increasing dependence on its e-commerce business, investors could become worried that same store sales growth will come to depend almost solely on its ability to compete with online retailers like Amazon. David Einhorn hinted at this last month at the Ira Sohn conference when he noted that Dick's could see its sales decline as Amazon ventures into the market.

Indeed, with the company only forecasting consolidated same store sales to grow by 3-4% in fiscal 2012, it seems highly likely given last year's results that a large percentage of that will be attributable to e-commerce. It is important to note that Dick's is not the only retailer that has seen e-commerce constitute a large percentage of its same store sales growth. For comparison purposes, Kohl's (NYSE:KSS) 2011 comparable store sales growth would have been negative were it not for a 150 basis point positive contribution from e-commerce, while Gap Inc (NYSE:GPS) would have recorded a 6% decline in same store sales in 2011 were it not for 200 basis points worth of assistance from 'comparable online sales' which brought the number up to -4%. Additionally, Target includes online sales in its comparable store sales growth.

The real threat however, is that a more experienced online retailer could make substantial inroads into the businesses of traditional retailers, putting pressure on profits by offering comparable goods at more attractive prices and in the process force companies like Dick's and Bed Bath & Beyond to spend substantial amounts of money to keep their e-commerce businesses competitive. Indeed this is exactly what is happening to Bed Bath & Beyond. In its most recent quarterly report, the home furnishings retailer said it would

"spend money on a new e-commerce distribution center, a new data center and a new website and some of the expenses came earlier than previously expected. The company currently sees the incremental operating costs associated with these major initiatives to be about 9 cents a share, occurring primarily in the second half of fiscal 2012"

This is widely thought to be a response to the launch of Amazon-owned Casa.com, a new home furnishings website. Here's where the connection to Dick's becomes abundantly clear. Casa.com was actually launched by Quidsi, an Amazon unit which also operates Diapers.com and Wag.com. In January, "online job postings by Amazon and Quidsi describe[d] a new 'sports and activities' business and an 'Outdoor Sportsman destination'", indicating that Quidsi might soon add sports equipment to its eclectic mix of websites. If this happens, Dick's could end up in the same position Bed Bath & Beyond has found itself in: spending more money on e-commerce than it would like and attempting to keep customers from defecting to an Amazon-backed site offering incentives to buy online.

The question is whether Dick's can compete effectively in the online segment. If it fails to grow its e-commerce business fast enough, its comparable same store sales could flat line all together, something no investor wants to see from a retail name. Notably, the company's e-commerce business grew at 33.4% in the first quarter, compared to 36.4% in fiscal 2011 and 38% in 2010. In other words, the growth is already slowing at a time when Amazon may be set to enter the fray. Although this story could take several quarters to play out, the long-term bet seems to be short Dick's or long Dick's puts.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in DKS over the next 72 hours.