DKS management spent time highlighting the strong business trends with open stores “doing very well” comping up and ecommerce seeing triple digit growth. The team talked about clean inventories and being “very bullish on the back half of the year in terms of the spend and generating the consumer demand”. The early 2Q sales results are good, but the stock appears to already be pricing in a very rapid earnings recovery while the demand environment is likely to remain volatile and margin profile is going the wrong way with some potential long term pressures. Is there $3+ in earnings power for DKS over a tail duration? Possibly. We’re at $2.75 for 2022. But that’s 2 years from now, and we don’t think the stock deserves a teens multiple today on that earnings given the needed discount rate in a very risky consumer environment – especially with the consensus high by nearly 25%. This is perhaps the biggest issue with current prices of many retail stocks. It's as if they are trading on 3 year out earnings without applying a discount rate within its present value, meaning your capital is unlikely to see any return for years buying at these prices. DKS will likely prove to be the last brick and mortar sporting goods retailer over the long term, but keep in mind much of the store is not much different from being an apparel retailer (56% apparel and footwear, some sports related, some not). There is some share to win with competitors going away, but also potentially some margin to sacrifice with a likelihood of channel and merch mix headwinds. If having to pick a side today we lean short at this price, but with near term sales momentum and the short interest already spiking to 24%, this isn’t an immediate candidate for our Best Ideas list.
1Q was likely much as people expected, though the numbers were materially worse than what consensus had modeled. Sales early in the quarter, through March 10th were up 7.9% accelerating from last quarters rate. We should note weather was favorable late Feb to early March, and Modell’s was faltering while preparing for bankruptcy, both helped comps in the early Q. Modell’s filed on March 11th and started liquidation sales shortly after. After DKS store closures in March from Covid-19, sales finished 1Q down 30% with ecommerce up 110%. That implies stores were down about 50%. Also ecommerce reached 39% of sales with 40% of online being fulfilled via curbside pickup since curbside launched. Margins were significantly impacted from both merch margin pressure and deleverage throughout the P&L. Gross margin down nearly 1300bps, and EBIT margin down 1800bps.
There wasn’t a ton of detail provided on the margin puts and takes. That is not unique for DKS, however this quarter is perhaps the most important quarter for which to understand that detail. The channel shift was noted as a drag, and that’s still an important area of debate for DKS as the company has downplayed ecom mix impacts historically, but the numbers/commentary this quarter imply there is a continued margin hit as the business goes more ecom. The company talked a lot about curbside pickup (as have others), and the long term opportunity for it. Curbside is simply a slightly more expensive BOPIS operation, and we still question the cost allocation of these store fulfillment offerings. How does rent and SG&A get allocated, whether the store is closed or open? Ultimately we think the long term trend will be that the consumer demands more and more that products be delivered to the home at increasing speeds. Store fulfillment is a cost saver for the near term, but not a real long term strategy. And nothing will be able to match the margin profile of traditional brick and mortar 'fulfillment' where you stock shelves and the consumer hand picks the goods from the shelves, and ‘ships’ it to their house themselves. Covid-19 is permanently taking up online penetration industry-wide, and is perhaps driving a higher desire for at home delivery with less overall consumer mobility.
On the 2Q trends, the company said in the first 4 weeks, with 44% of its stores remaining closed on average comps decreased only 4%. This appears to be bullish as it implies sales nearly flat with almost half the store fleet closed. Ecom is up 250% so far, which adds about 30pts of comp. Still that means rather strong performance (positive) from open stores. This demand makes sense to us, stimulus should be helping spending, and in May people are looking for backyard sporting goods to keep busy while stuck at home. Plus home fitness and outdoor are categories that should be strong as consumers lost the ability to workout in gyms. At the same time Modell’s was forced to suspend its liquidation sales around Covid-19 giving up share to DKS, though it should be resuming its liquidation soon which will be a near term sales headwind for DKS.
Lease deferrals/abatements:
“It's important to note that while we have successfully negotiated payment term deferrals and rent abatements, this didn't materially affect the P&L in Q1 as deferrals don't change the total cash payments and abatements are spread over the remaining life of lease.”
Convert dilution:
Hedges mean that the dilution from the $575mm notes offering starts at $52.42, and the notes carry 3.25% coupon.
