Waiting for the Season to Start

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

If investors are waiting for better results from Dick’s Sporting Goods (NYSE: DKS), they may have a few months to go. This company’s results have been fairly impressive given the breadth of competition from companies like Foot Locker (NYSE: FL) and Amazon.com. While the growth from companies like Nike (NYSE: NKE) and Under Armour (NYSE: UA) may help Dick’s move forward, the company needs to improve and this improvement can’t come quickly enough.

Waiting for What?

Last quarter, Dick’s suffered from negative same-store sales, and investors sent the shares down on worries that this could be epidemic. At the time, this concern seemed overdone because last quarter is historically weaker than the rest of the year. In fact, in March the company’s comparable store sales decrease by 2.2% was actually an improvement over the 2.5% decrease the year prior.

However, this quarter’s same-store sales drop of 3.8% compares horribly to the company’s increase of 8.4% last year. If investors believed that three months would solve the problem, they were wrong. When you consider that analysts are calling for 15.9% EPS growth over the next few years, Dick’s is going to have to do much better than this.

While Foot Locker doesn’t have the same ability to increase its store count in the way that Dick’s can, analysts expect nearly 11% EPS growth over the next few years. With Nike growing by 11.8% and Under Armour growing by 21.7%, Dick’s and Foot Locker should both benefit. However, without a turnaround in their same-store sales growth, Dick’s growth may be muted.

Make Room

The good news is, Dick’s can improve in two specific areas over the next few years. First, the company can manage its inventory more efficiently. Whenever I look at a retailer's inventory, I try to compare it to their current quarter sales to get an idea of how much inventory they have to carry to create the sales.

In the last three months, Dick’s percentage of inventory to current quarter sales was 98.35%. By comparison, Foot Locker carried 71.37% of inventory to their current quarter sales. In the past, some analysts questioned Under Armour’s inventory management, but recently the company’s inventory to current quarter sales was just 68.6%. However, if Dick’s wants a model to follow for inventory management, they should look at Nike, which carried just 53.81% of inventory to current quarter sales.

Partially through inventory management, and partially through making sure they offer the right products at the right price, Dick’s can also improve its gross margin. In the last three months, the company’s gross margin was 30.87%. While Under Armour and Nike don’t have to stock retail stores like Dick’s does, these two companies carry gross margins of 45.93% and 44.22%. In a more direct comparison, Foot Locker reported a gross margin of 34.25%. Given that Dick’s has the lowest gross margin of the group, it seems reasonable that the company can improve in this area.

Go With the Flow

If Dick’s can improve its gross margin and inventory management, one natural result should be the company’s free cash flow would improve. Investors should certainly hope so, as Dick’s ranks second to last in its peer group.

The best way I’ve found to compare companies' free cash flow generation is by looking at free cash flow generated per dollar of sales. By this measure, Dick's generated about $.05 of free cash flow per dollar of sales over the last 3 months. By comparison, Foot Locker generated about $.07 of free cash flow per dollar of sales, and Nike led the way with about $.29 of free cash flow generated. The only company to perform worse than Dick’s was Under Armour, which generated less than $.01 of free cash flow per dollar of sales. However, it should be noted that Under Armour spent heavily on marketing expenses in the current quarter.

If You Don’t Want to Wait

Buying Dick’s stock at the present time, means collecting a less than 1% yield and hoping that the company can fulfill analysts expectations of nearly 16% earnings growth. Given the company’s challenges, this earnings growth assumption is no sure bet, and investors may want to look elsewhere for better opportunities.

Foot Locker seems like a reasonable alternative, as the stock pays a yield of 2.3%, and though analysts expect earnings growth of just under 11%, the stock also trades for a cheaper multiple than Dick’s. While it’s difficult to recommend Nike at over 23 times projected earnings, with a just 11.8% expected growth rate, Under Armour is growing much faster at nearly 22%. While it’s true Under Armour is no great value at nearly 40 times projected earnings, at least the company’s earnings growth is intact, which is something that can’t exactly be said of Dick’s.

Investors in Dick’s may be waiting for the season to start, but if management doesn’t correct several problems soon, this game may be over before it begins.

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Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Nike and Under Armour. The Motley Fool owns shares of 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!

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