DKS: Drink Facts, Not Cool Aid

Apologies in advance if this sounds self-promotional (it's usually not my style) but I've been convinced for a while that the bullish consensus on Dick's is dead-wrong. The market drank the cool-aid and ignored the facts -- that unsustainable comp and margin drivers were masking one of the most aggressive rent structures in retail. It's unfortunate that the market does not care about these things until management says so.

Even with today's guide-down and subsequent downgrades, I don't think people really get the real story here. With the stock going from $27 last night to $20 pre-market, and now to $23, it's clear that the market is scratching its head and trying to make sense of what to do here. While every fundamental story has its price, there's still plenty of risk not priced in here.

It's IMPERATIVE to take a bigger picture view on this name. It is really a question of 'Then' versus 'Now.'

THEN: Over the last three years, Dick's has been blessed with the following.
1) A rock solid consumer.
2) The Under Armour comp cycle, which disproportionately helped DKS.
3) An easy competitive landscape - as Sports Authority was taken private by Leonard Green and subsequently closed stores. Also, other Sporting Goods retailers (like Hibbett) were behaving nicely as it relates to store expansion.
4) DKS took up its high-margin private label business from less than 10% to a low/mid teens rate today.
5) Major vendors like Nike, Adidas, Columbia, Champion and Russell funded DKS' margins through significant discounts and flat-out price rebates in order to hold off share loss to Under Armour. This was funded largely through lower sourcing costs due to cheaper Asian imports.

While the business was rocking and rolling, no one on Wall Street cared that Dick's has among the most aggressive rent structures in all of retail. In other words, it is moving into locations that its profitability cannot afford relative to Kohl's, Bed Bath & Beyond, and Best Buy (examples of companies with whom it competes for retail space). As such, Dick's needed to promise higher rents in the outer years or sign less favorable terms to secure the locations. The strength in the business more than offset these higher costs, so Wall Street did not know (or care) about the risk. The stock was subsequently revalued from 8x up to 16x EBITDA.

1) The consumer took a 180 turn and is on very shaky ground.
2) The Under Armour comp cycle is done like dinner. Still a great brand, and still growing nicely. But the days of 75%+ growth at DKS are long over.
3) Competitors are actually adding stores again, and are starting to step on each others' footprint (Sports Authority in Florida, Academy in Texas, and everyone in California).
4) Private label is close to tapped out without sacrificing margin.
5) I'm convinced that vendor terms will be less accommodating than in prior years bc a) UA growth is slowing and the need for competitive response is not as great, and b) there's no way that vendors can be as generous when they are being faced with 8-10% increase in their cost of goods sold. Let's not forget that 'Dick's Sporting Goods' is largely an apparel and footwear retailer. It is absolutely not immune to higher product costs. Check out recent postings on the topic.

So now we're looking at a situation whereby all the factors that hid high occupancy escalators are ebbing, and the real risk to the P&L is being exposed. Yes, the stock is more fairly valued today than 24 hrs ago. But 9x EBITDA and 16x earnings relative to the rest of retail? I don't get it - especially when DKS is just starting what is likely to be at least a 12 month downward P&L trajectory.