This note was originally published March 11, 2013 at 15:40 in Retail
A few people have asked us today as to whether we think that the DKS stock price reaction is overblown. If anything, we think it’s underblown (if that’s not a real word, now it is).
This has nothing to do with missing the flow of cold weather patterns or getting ‘Lanced’ by its stagnant inventory of Livestrong treadmills. But rather, it is a company in a mediocre business that is running at peak margins at a time when the outlook for comps (low single digits) is below the rate needed to leverage occupancy, deferred investments on the P&L are eating up an incremental 5% of earnings this year, and capex is trending up an incremental 20%.
Furthermore, let’s not forget that DKS falls into the bucket of names that has high risk of share loss to dot.com competitors and brands’ direct growth initiatives, and at the same time we see the company openly admit that it has underinvested in the infrastructure needed to take its ecommerce platform to the next level.
We get the whole point about DKS being a ‘best in breed’ retailer. But this is not necessarily a breed that needs to be owned.
We think that the crux of where DKS is in its cycle can be summed up in the Profitability Roadmap below, which shows the progression of margins vs. asset turns. Retailers, as we all know, can improve either one of those at any given point in time, but it’s when they improve simultaneously that real value is created and the stocks outperform materially (0.92 performance correlation). This is exactly what DKS did from 2009 through 2011, and it accounted for a 4-bagger in the stock.
But today, we think that we’re stuck at a point where margins will tread water, and it will be on an incrementally larger operating asset base. That is the ultimate recipe for a value trap.