Let’s be clear…this DKS Long call scares the Living Daylights out of me. This is an atypical call for McGough. Being ‘scared’ of something is not the Hedgeye way. We rely on #process. As such, I’m sticking to our research process on this one. Maybe the call gets thin – really thin – when I start talking about a ‘baseball bat replacement cycle’. But comp (which I hear is pretty important) is the second of four pillars of our call on this one – my team needs to quantify every last put and take on that one…
- New Store Productivity getting better. I can prove this mathematically. Supply coming out of space for the first time since Herman’s went bust for the second time – before UA IPO. DKS scooping up the 31 prime TSA leases – while the other 420 remain in bankruptcy court. Not like when BBY put Circuit out of business, and the stores came back as PC Richards. So DKS acquires best properties in prime markets and builds new stores on the cheap in ‘top 250’ MSAs.
- Comp. Nike needs DKS more than ever. Remember Finish Line in 2002/3 during FL conflict? Then FL in 2004? Nike drove traffic, ASP and comp in a declining mall traffic environment. We’re modeling a 200bp comp increase due to the weighted avg ASP/Mix boost to DKS. UA is on the ropes. DKS launching ‘second skin’ line to stick it to UA. UA need to flex on price/terms for the first time since its IPO.
- Gross Margin: Anniversarying TSA Ch11. 24% decline in gun registrations. Ammo cycle is more critical and both ‘undermodeled and underappreciated’ -- CAB/BassPro/GMTN/CWH consolidation. Golf consolidation and clearance finally done (Golfsmith, rounds played at end of bottoming process, Taylormade back on the block).
- SG&A: Cut e-comm payment to GSIC in January, which opens up 200bp in a pad. This almost certainly will be reinvested in the model – especially given that e-comm trends look like death. But’s the inverse of what we see at FL, which grossly underinvested when NKE drove it’s business.
Plus, call option on AMZN buying it, or doing a deal so AMZN uses DKS as its local sporting goods showroom and DC. I know this sounds absolutely ridiculous, but give me a call and I’ll explain the logic/math. It’s very defendable.
The bottom line is that we’re 15% above consensus for 2018. The stock is trading at 9x our numbers. Let’s give DKS a 12x multiple on an above-consensus number on a company where there’s more hatred/apathy than BBBY. There’s a $54 stock (+60%) within 6-9 months. But yes, I get it that this is a risky call (aren’t they all?). It’s also one with very defined dates and gates. If I don’t see three of our four pillars play out by the end of 4Q (TREND duration), then I am out of this call faster than Trump can pick a fight with North Korea.
Revenue
Nike ASP and Penetration Rising
With the bottom 20% of vendors being cut from Dick's stores, more room is being made for Nike to grow within.
Premium footwear decks should be in 200+stores by now, almost 2X the 117 stores which had the decks at the end of 2Q last year.
The way we are doing the math, incremental Nike ASP will drive about 200bps of comp. If Adidas and UnderArmour follow, the benefit is upwards of 300bps.
Improving NSP and Real Estate Profile
The properties and new markets acquired from TSA are much higher quality in terms of population on disposable income than the traditional DKS markets. As such, the total sporting goods spending within a 25 min drive of the acquired stores is over 2x that of the DKS core stores.
This means new store productivity will improve, it inflected in 4Q, improved again in 1Q, and we expect that trend to continue.
Baseball Bats
Effective January 1, 2018 USA Baseball, the national governing body for the sport of baseball in the U.S., will adopt a new bat standard. All bats must have the USA Baseball logo on it to be used in game play. The new bats will go on sale beginning Sept. 1. Most leagues including Cal Ripken, Little League, Dixie Youth, and Pony Baseball will only allow the new bats. This will affect children from t-ball to jr. high school.
We estimate the rule change would drive about 0.5% to SSS next year, but most of it will be in Q1. If Dick’s can attach some more sales of baseballs and cleats the benefit could be even larger.
Under Armour Slowing
We have to point out that even with launching in ~1500 new distribution points with KSS and DSW this year, UA North American revenue still slowed to 0%. Going into Kohl's stores is the move of a brand that is struggling to find quality growth.
UA needs DKS right now and DKS should get all the UA product it desires, but the brand is not growing as it once was and the product is not resonating with the customer the way it used to.
Gun Sales Bad, but Should Inflect by Year End
The trend is no shocker, since the Trump election background checks for gun sales have slowed significantly.
July saw the worst growth since 2013.
We've seen the numbers hit CAB, as half of CAB’s 9.7% 2Q comp decline was firearms. Ditto for BGFV.
Guns sales cycle around these "regulatory risk" events and bounce positively as much as they bounce negatively.
Golf
Ultimately we think the golf industry is in a bottoming process, but we've seen mixed datapoints out of the golf brands in 2Q.
On the oneside, Callaway saw excellent growth in woods sales around its Big Bertha Epic driver success this spring/summer. That's DKS bullish.
Ball sales weren’t as impressive. Callaway balls were up just 4%, and Titleist golf ball sales (market share leader) were down 7% in 2Q. That's DKS bearish.
Comp Breakdown/Traffic
TSA closing contributed some traffic benefit to DKS in Mid to late 2016.
Now has to comp against that traffic trend which will be more difficult sequentially in 2Q and 3Q.
Margins
SIGMA / Merch Margin
Sigma Inflected negatively, with gross margins down and inventory down in 1Q on a bullish setup.
DKS is comping against a merch margin "up slightly" each quarter from 2Q-4Q last year.
Ecom Costs
DKS is still lapping duplicate costs in ecom last year while building its own operation and still paying GSIC its royalty.
Potential margin cushion is 200bps+, not all that will flow through, but it give DKS some room to negotiate SG&A to help meet EPS expectations.
