Prepared by Michael, analyst at BAD BEAT Investing
We have traded Dick’s Sporting Goods (DKS) several times in the last few years, and is a favorite among day traders over at BAD BEAT Investing. The stock has been pulling back significantly in recent weeks. WE think shares are a buy in the mid-$40 range if the market allows. The company will report Q3 earnings in a few weeks. In this column we will look at results from Q2 as a proxy for what to look for in Q3. We think you have to look not just at the top- and bottom-line performance but need to look more closely at comparable sales and margins, which we believe will continue to drive investor sentiment. E-commerce must continue to be a focus while assessing the company’s work toward property management.
Earnings in Q2 strong but we will see if Q3 holds up
In Q2 2020, the company reported net income of $276.8 million, or $3.21 per share, on an adjusted basis. Not only did this surpass our bullish expectations of $2.00 per share, but it was beyond the highest end of the company’s own expectations, and $1.96 better than consensus. This is also a nice growth from last year’s $112.5 million, or $1.26 per share. With the outperformance relative to our own expectations, we believe this result was solid and deserves praise, but more importantly, we need to understand how the company got there and the implications for future trading in the stock.
Comparable sales shine
We had expected positive same-store sales in Q2 and expect them in Q3 as well. We care about sales and the input costs to generate those sales. We have particular interest in comparable sales when examining retail. We were blown away by comparable sales. Consolidated same-store sales increased 20.1%. That is simply stunning. This is a stark turnaround from Q2 2019 where consolidated same store sales increased just 3.2%.
So why the increase? Well, Dick’s saw increases in both average ticket and transactions, as well as growth across each of its three primary categories of hardlines, apparel and footwear. With this increase in same-store sales, coupled with a strong merchandising strategy, and online strength led to a year-over-year revenue increase of 20.1% to $2.71 billion. This was ahead of our expectations slightly for $2.60 billion in sales. While comp sales impressed, the result reflects a real effort by the company to improve online sales.
Continued improvement in e-commerce
We’ve been diligently watching e-commerce all across the retailers we follow. While we were pleased with comparable sales relative to our expectations, our expectations were met for online sales growth. We thought online sales could jump as high 100%, but we were wrong here. Online sales increased a solid 194%, however. This helped bring revenues ahead of our expectations. While more and more shoppers are purchasing materials online, we believe Dick’s aggressive promotional activities to protect market share helped boost online sales. In fact, online sales represent an increased percentage of total revenues each year. With such promotion, we were concerned margins might get hit, but were expecting them to be around flat.
We continue to believe that margins will remain pressured for several quarters to come as the company continues to transition and adapt to new market realities of competition and heavy promotion in this COVID period. However, we were wrong here with gross margins hitting 34.5%, from 30.0% last year. We do note that online sales tend to have lower overhead, so the more sales online the better. We see them as a higher margin source, so we think margins can stay over 34% in Q3 2020 as online remains a strong focus. From an operating margin perspective, we want to see the company get more aggressive with property, a theme we have harped on across various brick and mortar stores.
Be aggressive with closing physical stores
Online sales increase every year and the pressure on physical stores is strong. We will be watching this closely in Q3. With sporting goods and footwear there is some insulation from the online pressure, especially if the prices are competitive, thought COVID has caused a ton of issues on this point.
We think Dick’s needs to be more aggressive in property management and be very tactical when opening new shops in key markets. We want it to close underperforming stores and waste no time in keeping losing operations running. The store count has remained roughly stagnant over the last year with very few closures. In the second quarter, Dick’s opened one new Dick’s Sporting Goods stores and two specialty concept stores. The total stores have barely moved in a few years, with 860 stores total at the end of Q2 2019, and 852 at the end of Q2 2020. We thought more shops would close.
One of the concerns we had with the company was that, by refusing to shutter losing operations, it could be costly to the balance sheet. That said, the balance sheet is in okay shape but there is moderate debt that is higher than a year ago. Dick’s ended Q2 2020 with approximately $1.1 billion in cash and cash equivalents and no outstanding borrowings under its revolving credit facility. This is a huge improvement from just a year ago where there were hundreds of millions of dollars in borrowings.
At present levels, shares are still attractive on a valuation basis at 11-12 times 2010 earnings based on the present share price of $51. This is because we see this fiscal years earnings of $4.25-$4.75.
Longer term, if you believe that the athletic sector will remain strong, while consolidation remains possible, shares are still attractive. If the market allows, consider some buying in the mid-$40 range.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.