Here’s what’s top of mind for us this morning.
We were asked yesterday whether it’s too late to go long DKS. After all, the stock has been a monster – up 44% for the year-to-date, and 16% since Sports Authority filed on March 2nd. In addition, the name has become a hedge fund hotel and no longer looks cheap at face value. But still, we feel good about being involved on this one and even adding here. Would we rather add more on dips? Absolutely. But we’re not sure we’ll get ‘em.
First off, yes, the stock is up 44% ytd, but it’s flat versus a year ago – about in line with the market. That’s no reason to buy a stock, but it is an important consideration.
Our key thoughts are focused around the Sports Authority bankruptcy. No, that’s not exactly a proprietary idea. It explains away virtually all of the stock move from $34 to $50. But what we think is a unique thought is the dominoes that were set in motion by TSA’s demise, how vendors (esp Nike) will certainly respond, and most importantly, the duration over which this will benefit DKS. If you’re looking for a 2-3 quarter payback from TSA, and the stock, you probably got it. But the reality is that this benefit is likely to last 3-5 years, and should allow DKS to out-comp every peer except the internet, and retest a peak 9% margin level – which is 2 full points above the consensus. That translates to about $6 in earnings, versus the Street at $4.25. As lofty as this may sound, we’re likely looking at a 20x+ multiple on that number, or $120. Yes, that would make this a 3-year double.
We’re still doing the research to gain conviction in that number, but think that it’s more likely it gets there than where the Street is today.
The Nike Dynamic
People often forget the following facts. And they ARE facts.
1) First off, this is a generational shift in product distribution. There are not many ‘generational events’ to invest in out there.
2) Yes, DKS has been waiting for this to happen, but mark my words, it also helped cause it to happen (a la BBBY/Linens, and Best Buy/Circuit). We’ve been critical in the past about DKS’ business model, but never about Stack and his management team. Yes, it blew up its golf business. But as it relates to the core sporting goods business, there’s really no one better.
3) Nike made a tangible decision to invest in e-commerce as far back as 2005. That’s when its capex for DCs, warehousing and e-comm infrastructure started to grow, and when we started to see accelerated SG&A in e-comm headcount.
4) At that time – whether Nike outwardly admits it or not (or even realizes it) the company started to stuff the US wholesale channel to pay for its e-comm investments.
5) In the ensuing decade, its sales penetration inside Foot Locker, for example, went from 50% to 73%. Yes, 73% of FL’s inventory purchases were/are Nikes. There’s only one way for that number to go – and it’s down.
6) Sporadically over the same time period we saw the Sporting Goods channel begin to evaporate (‘08/09, and this year). Make no mistake, Nike absolutely positively NEEDS this channel for its US business to grow.
7) People are all jazzed up about the first round of Nike shoe walls that will be in place at DKS by end of year. They should be. But what they should be more excited about is the comp growth it will bring to DKS in the form of higher ASPs for the better part of 3-5 years. There’s a huge impact there on both sales and margins, as FL showed us in this economic recovery.
Keep in mind that this is a zero sum game. In other words, TSA had roughly $3bn in revenue. Half of that will evaporate, and at best we’re looking at about $500mm-$750mm in revenue directly from TSA. But the bigger kicker that people won’t count on is a similar contribution from better Nike product across the portfolio – and it should come at a higher margin via ASP and better traffic.
In the end, Foot Locker loses. Finish Line loses. Hibbett Sports loses. All will have 2 Nike-issues. 1) no longer seeing an increase in Nike (which is a negative) and 2) likely seeing a decline – especially FL.
Nike wins as it secures a better US distribution partner, though much of this will be robbing Peter to pay Paul.
DKS is the biggest winner, as quantified above.
One of our key points on Nike is that the company will hit $11bn in e-comm/DTC revenue versus guidance/The Street at $7bn. THE KEY to Nike accelerating its progress will take the shape of some form of US channel conflict. We started to see that with FL on its last conference call. It should get meaning fully worse, which will cause Nike to slingshot the part of its business that actually should be growing – and that’s not brick and mortar. The point here is that the anecdotal comments from retailers are likely to be increasingly anti-Nike. We’re fine with that. In fact, we want to see it. But it causes us to have a ‘buy on dips’ positioning as it relates to Nike.