Not the Best Way to Play Sporting Goods

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

Dick’s Sporting Goods (NYSE: DKS) is a leading operator of sporting goods stores, with over 550 locations in 43 states.  Dick’s has done an excellent job of growing revenues over the past decade (see chart), and as a result, shareholders have been handsomely rewarded as the stock has climbed from $3 in 2003 to the current level of just under $50. 

<img src="/media/images/user_14267/dks-revenue_large.png" />

However, I believe that the stock may be getting a bit expensive at this point.  I don’t believe that the high growth rate seen in the past will continue enough to justify the high valuation the company currently trades for.  First, let’s take a look at the company and where it is going.

Dick’s Sporting Goods stores offer a full range of sporting goods equipment, apparel, and footwear.  Dick’s carries merchandise from over 1,200 suppliers, the largest of which is Nike (NYSE: NKE), which represents about 15% of the company’s merchandise.  Under Armour (NYSE: UA) also has a very significant presence in the stores, with their apparel usually front and center.

Speaking of those two companies, although Nike is still a dominant market leader, I think it is very possible for Under Armour to overtake them as the number one manufacturer of athletic clothes in the not-too-distant future.  I have written a full post about Under Armour’s growth potential, however here is a brief summary:

Under Armour’s revenues are currently just under $2 billion a year and rising rapidly.  They are widely known for their synthetic performance apparel (compression-wear), a concept that they practically invented and have a 60% share of the $3 billion annual sales of this type of clothing. 

However, it was just over a year ago that they began to sell cotton performance apparel, which is a much bigger $12 billion market, in which Under Armour has barely made a dent.  It is not inconceivable, given their reputation for exceptional quality, that they could make serious inroads in this arena as well.

Nike is still the footwear leader, and I see this continuing for years to come.  However, the stock is a bit too expensive right now at 22.8 times earnings.  If I’m paying that much of a premium for a company, I want it to have growth potential like Under Armour’s.

Back to Dick’s Sporting Goods, which is fortunate enough to sell both of these great companies’ products:

Growth Strategy

In the past decade, Dick’s has aggressively expanded its number of stores, as well as grown through acquisitions in order to enter new geographic areas, as was the case with the 2004 acquisition of Galyan’s Trading Company.  They very well may continue to open new stores, but I believe it will be at a slower rate than in the past.

Dick’s has also gained market share as smaller competitors such as local sporting goods stores have ceased operations.  This is also one of the most referenced catalysts mentioned in analyst reports.  However, if you believe (as I do) that the economy has significantly improved and will continue to do so, this simply cannot be counted on anymore. 

Valuation/Competition 

Dick’s is a pricey stock, currently at 22.6 times TTM earnings.  While it is true that the company has a very nice balance sheet, with $600 million more in cash than it has in debt, I don’t think the lofty valuation is warranted. 

When Dick’s reports fiscal year 2013’s earnings in early March, they are expected to have earned $2.56 per share, which is projected to rise to $2.92 and $3.40 in 2014 and 2015, respectively, a forward growth rate of 15.3% annually.  However, as I mentioned before, I don’t think that the main growth catalysts can be counted on as much as analysts seem to think.

For comparison’s sake, the next largest publicly traded sporting goods company is Cabela’s (NYSE: CAB).  Cabela’s has a smaller physical presence, with around 40 stores. However they do much more direct business, through both its website and catalog distributions.  Cabela’s is a little more cheaply valued, at 20.4 times TTM earnings, however with a slightly lower forward growth rate of 14.5% projected.  Out of the two companies, I prefer Dick’s, since I believe their product lines are growing in popularity quicker than Cabela’s.

However, the biggest threat to the company going forward is giant discount retailers, particularly those that are online like Amazon.com (NASDAQ: AMZN).  Because of their sheer size (and free shipping), it is almost impossible for other retailers to keep up with Amazon’s pricing.  For example, a quick search on Dick’s website for an Under Armour Coldgear shirt reveals a price tag of $49.99, marked down by $10.  The same search on Amazon lists the same item for $3 less with free shipping.  Now, I’m not a fan of Amazon as an investment due to its astronomical valuation, however given the choice, consumers will choose the cheaper product.

Conclusion

While I believe in Dick’s Sporting Goods as a company, I’m not bullish enough on retail to pay such a lofty price for growth that I’m not convinced that the company will deliver.  I’m more of a fan of some of the brands sold at the store.  For example, if Under Armour’s market share doubles, that will not necessarily boost Dick’s sales; it could only hurt Nike’s and other competitors. 

The bottom line is that is you are a fan of fitness equipment and athletic apparel, there are better ways to play it in your portfolio.


KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Nike, and Under Armour. The Motley Fool owns shares of Amazon.com, Nike, and Under Armour. 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!

blog comments powered by Disqus