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Can Dick's Sporting Goods Keep Sprinting Ahead?

Frank is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

While investors are busy hanging on every word that comes out of Washington that even remotely rhymes with cliff, consumers have been busy filling shopping carts with gifts this holiday season.  A recent trip to my local Dick's Sporting Goods (NYSE: DKS) revealed to me that most consumers aren't remotely thinking of the "fiscal cliff."  Consumer confidence numbers show the U.S. consumer is pretty happy where things stand.  This shopping trip also revealed that consumers are pretty happy with Dick's Sporting Goods.  Investors in the small company have to be pleased as well.  Dick's shares are up 37.5% in 2012.

Dick's Sporting Goods is a specialty sporting goods retailer that specializes in sporting goods equipment, apparel and footwear.  The company also owns and operates Golf Galaxy, LLC, a specialty golf retailer.  Capitalizing on an increased focus on health and fitness in the United States, Dick's has seen explosive growth over the last several years.

Can Dick's Keep Growing?

Dick's currently has 592 stores, 511 Dick's sporting Goods and 81 Golf Galaxy.  As of the third quarter, the company had opened 31 new stores in 2012.  The store count has been growing as Dick's expands its footprint across the United States.  Just five years ago, the company had only 417 stores.  As the store count has grown and consumers have become more familiar with the name, the company's online business exploded.  The company reported that its eCommerce business increased 46.7% in the third quarter over the same period last year.  In the 39 weeks that ended the third quarter, Dicks reported net sales increased 12% primarily due to store count growth and a 5.6% increase in same store sales.  The company states that each 1% increase in same store sales increases net income by approximately $4 million.

Management has made clear that it intends to sustain the current levels of growth for the company by continuing to expand its footprint.  They believe that the ideal footprint includes 900 stores in the United States, a 52% increase from today's levels.  Competitor, Hibbett Sports (NASDAQ: HIBB) has 848 stores.  To date, Dick's has not made plans for international expansion.  As long as the consumer holds up and Dick's can continue driving foot traffic into its stores, this model should work to consistently increase sales.  Margins are holding up as well.  For the 39 weeks that ended the third quarter, merchandise margins expanded by 38 basis points.  The ability for Dick's to continue its growth trajectory depends on its ability to open new stores and grow the eCommerce business while maintaining margins.

The good news is that Dick's has a pristine balance sheet which makes it easier to continue expanding.  The company has virtually no debt and finances new store openings almost entirely from cash flow.  The company does have a $500 million revolving credit facility from which it had used $11.3 million in the form of letters of credit as of Oct. 27.  Dick's has generated about $400 million in cash from operations in each of the last three years.  Much of that cash has been put to work financing new stores.  However, this year Dick's made a couple of strategic purchases to add to its brand power.  In March, Dick's purchased all intellectual property rights to the Top-Flite brand for $20 million from Callaway Golf.  With these rights, the company acquired all Top-Flite trademarks worldwide.  In August, Dick's agreed to purchase the Field & Stream mark in hunting, fishing and camping categories for $24.5 million.

Dick's Sporting Goods has plenty of room to grow.  Dick's is outperforming Hibbett with far less stores.  When a Dick's Sporting Goods opens in a new area it seems to dominate the other sporting goods retailers.  Another competitor to watch is Cabela's (NYSE: CAB). Though the company only operates around 40 destination style stores, they are a formidable competitor in the hunting, fishing and outdoor segment.  They compete directly with Dick's Field & Stream brand.  Cabela's is growing as well, opening several new stores per year and has a strong eCommerce and Catalog business.

What Is Dick's Worth?

As I stated earlier, Dick's stock has performed very well this year.  It's up 37.5% year to date.  Dick's has a P/E of 23.5 and trades at under 20 times next year's earnings estimates.  The company's return on equity is 16.65%.  Since we are looking at Dick's ability to grow and Dick's finances its expansion from cash, it's important to look at the company's operating cash flow.  Dick's is currently trading at 14.4 times operating cash flow.  Historically (Dick's went public more than 12 years ago), the company has traded at 12.6 times operating cash flow.  Dick's is growing its cash flow at an annual rate of 18.9%.  Although the stock appears slightly overvalued on this historic basis, the growth rate suggests that Dick's will be able to continue expanding at its current rate. 

Comparatively, Hibbett Sports is trading at 16.3 times operating cash flow.  Hibbett historically traded at 14.5 times operating cash flow over the same 12 year period.  Hibbett is growing operating cash flow at a rate of 18.1%.  Though Hibbett trades at very similar multiples and has similar growth rates as Dick's, Hibbett already operates far more stores.  In my opinion, Hibbett is much closer to saturating the market than Dick's.

Dick's is projected to earn $2.92 per share in fiscal 2013.  Since becoming a public company, Dick's has normally traded at 19.4 times earnings.  This suggests a target price of $56.65 per share in 2013.  Based on Dick's expansion, per share earnings are expected to jump to $3.43 in 2014.  If Dick's trades at its historic P/E, the stock would trade up to $66.54 in 2014.

Dick's currently pays a quarterly dividend, yielding 1%.  The company just announced a special dividend of $2 per share to be paid before the end of the year.  They can afford it but time will tell if it actually makes sense.  My concern is because the special dividend will cost the company about $245 million it will slow down the expansion of its footprint or cause it to take on more debt.  Though it doesn't change my opinion of the company, this is one case in which I would have rather seen the money reinvested.

What Is The Foolish Bottom Line?

Dick's Sporting Goods has an excellent management team with what seems to be the right strategy.  However, Chief Financial Officer Timothy Kullman plans to retire in 2013.  This likely won't affect the long-term strategy of the company and it doesn't appear that he is leaving due to any internal problems.  The company is financing its expansion effectively through its growing cash flow.  With a clean balance sheet and a lot more room for growth, Dick's should continue to have a long runway.  However, given the current stock price the company seems to be fairly valued and pricing in a lot of this future growth. 

Investors may want to consider letting Dick's take a breather before jumping into the stock.  I will likely add to my personal position if the stock drops into the $40-$45 range.  The bottom line is Dick's is a great company with great management and a great strategy, but investors may want to wait for a slightly lower price.

fjconstantino owns shares of Dick's Sporting Goods. The Motley Fool owns shares of Dick's Sporting Goods. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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