DKS’ 2Q print validated our bear case that the company is putting up a greater proportion of incremental capital on both the P&L and the balance sheet for disproportionately less cash flow in return. Our view is that this trend (which also applies to Macy’s and Gap) will mitigate any kind of valuation support, as multiples have no business being near their tops when returns are rolling over like we see today.
Like many retailers quarter-to-date, sales trends were soft, and the company did not have a firm grasp as to why. It comped down for the second quarter in a row, and though gross margins held steady, inventories were up 12.4% on 6.6% sales growth. That’s not a good setup by any stretch for gross margins heading into the back half.
If there’s any bullish angle, it’s that earnings expectations might finally be down to more doable levels. But the reality is that this stock is still trading at over 18x current year earnings, which is downright expensive. Based on our model, it will never have over a 9% operating margin again (see our assumptions below). We’d need to see consensus estimates come down by about 25% in the outer years for us to back off of our bearish stance on DKS. That’s unlikely to happen.
Avoid the temptation to support it here. Let it cook.