Description

Academy Sports and Outdoors is a sporting and outdoor goods retailer based in Katy, Texas, which operates 259 stores in 16 states located in the south and southeast. Stores average more than 70,000 square feet, making them roughly 50% larger than peers like Dick’s Sporting Goods (DKS). The company’s huge boxes allow it to meet the customer’s every sporting and outdoor need from grills to soccer shoes to bicycles.  

Founded in 1930, customers have grown very loyal to the brand because of Academy’s commitment to providing the best price-value mix. Its commitment to value is evident in its guarantee to beat any competitor's price, online or offline, by 5%.

Background

Academy’s bigger box size, and focus on higher AUR, lower margin outdoor equipment, shows up in its unit economics, as sales per square foot in fiscal year 2021 – the year ending January 31, 2021 – were 50% higher than peers, but gross margins were 300 basis points lower.

As the table above shows, 2020 was an excellent year for all of the sporting goods retailers. This subsector of the market has been a major beneficiary of the pandemic because of the stimulus checks, additional unemployment benefits, and a lack of available experiences creating new pandemic-inspired outdoor hobbies like golf and camping. Combined with fewer promotions in the market due to a lack of inventory across retail, margins, and, accordingly, cash flows surged, leading to record results for all the sporting goods retailers.   

At Academy specifically, the pandemic helped to accelerate comps from the low single digits in the fourth quarter of 2019 into the double digits in every quarter since. The first quarter of 2021, boosted by two sets of stimulus checks was the high-water mark as comps nearly hit 40%. The strong topline results over the last seven quarters translated into Academy producing $970 million in free cash flow in 2020 and another $456 million to start 2021. 

2021 free cash flow is set to come in lower than in 2020, despite more than “comping the comp”, as Academy has been rebuilding inventory after it got very depleted during 2020. This has crimped cash flows by $335 million year-to-date. 

The record cash flows over the last two years have left the company with a much cleaner balance sheet. Ex-leases, it now has $698.5 million in long-term debt. The debt is made up of two tranches – both of which mature in November 2027 – senior notes that accrue interest at 6% with principal of $400 million and a term loan that accrues interest at 4.5%, which has an outstanding balance of $298.5 million. After accounting for its cash balance of $401 million, Academy’s leverage ratio, on a net debt-to-EBITDA basis, is less than 0.3x. 

After having bought Academy nearly a decade ago, the improved results from late 2019 into 2020 led Academy’s then-owner, KKR, to decide that the time was right to exit most of its position. Accordingly, Academy came public in October of 2020.

Investors, unsurprisingly, weren’t enthusiastic about the retailer, as they thought that this was just another retailer that was temporarily boosted by the pandemic but, in the long-term, set to be disrupted by Amazon. Accordingly, Academy’s IPO priced weakly at $13 – two dollars shy of the bottom of its original range of $15 to $17.

Academy's introduction to the stock market went from bad to worse on its first day of trading on October 2,2020 when the stock market fell after Trump's COVID-19 diagnosis, leading to Academy’s stock closing slightly below its IPO price. So it was technically a broken IPO – but just for one day… it never breached the IPO price again.

Having put its anemic IPO in the rearview mirror, Academy has delivered strong results in each of its first five quarters as a public company. Its shares are up roughly threefold since its IPO almost 15 months ago  Having handily beaten EPS estimates for all five of its reported quarters, it has been a pretty steady ride upwards for ASO shares, with notable pullbacks in early fall when supply chain jitters took over the market and more recently as both small caps and retailers have sold off dramatically since mid-late November.

ASO shares pulled back over 20% in recent weeks, despite having logged very solid third quarter results when the company most recently reported on December 10. Academy topped third quarter revenue expectations by 7% and reported a healthy 57% upside surprise to EPS, posting $1.72 versus $1.09 consensus.

With the pullback, the shares are now trading at a P/E of just under 6. The market is clearly expressing skepticism that results at Academy (and its peers) are sustainable.  Short interest is also elevated at 11% of shares outstanding.

Investment Thesis

Unlike the sporting goods sector skeptics, we believe sporting goods retailers have a number of trends that should not only help them beat back competition from online players, but actually lead to organic growth in the next decade. 

We’re most bullish on Academy, as we think they have the most avenues to self-help and operational improvements, which they’ll execute on under the leadership of former Foot Locker CEO Ken Hicks, who very effectively led a similar operational restructuring in his former CEO position.

At a P/E of <6.  Academy is a clear deep value play with a side of “bet the jockey.” If our thesis plays out, we think ASO shares could double in the next 12 months.

Industry-Level Thesis on Sporting Goods Retailers 

We believe that the best sporting goods retailers should benefit from three major trends that drive comps higher:

1.  shifting consumer preferences to outdoor activities.

2.  major brands, namely, Nike and Adidas, culling and consolidating retail accounts as they pivot towards more to DTC (direct-to-consumer) sales.

3.  the inherent benefits of selling retail goods via omnichannel versus pure online or offline.

Studies have long pointed to habits being sticky after two to nine months. It’s been well-documented that the pandemic has been a great customer acquisition tool for a host of technologies and hobbies, and we expect these to be sticky given the pandemic has now gone on for nearly two years.

With remote and hybrid work now likely to be much more common post-pandemic, we expect that surging interest in golf (rounds played were up 16% year-to-date through July 2021, after increasing 14% in 2020) and other outdoor activities like grilling and camping (visits to Grand Teton National Park in April 2021 were nearly 50% higher than April 2019) is here to stay.

This is showing up in sporting goods retailers’ sales numbers, as sales jumped 14% at DKS, 18% at Academy, 15% at Hibbett, and 4% at Sportsman’s Warehouse in the latest quarter, despite all four seeing sales growth greater than 15% in 3Q20. Simply put, these companies are “comping the comp.”

While the shift of the COVID-19 pandemic to an endemic virus and the easing of restrictions on global travel and various live experiences may reduce spend on outdoor hobbies in the short-term, spend on these hobbies should remain meaningfully elevated versus pre-pandemic levels, as these hobbies are likely now lifelong ones.  

While the pandemic-induced shift in consumer preferences is one-time in nature, it was a very effective consumer trial and acquisition event for sporting goods retailers. As the growth environment normalizes, the next avenue to growth for Academy and some of its larger peers is market share gains. The shift by brands to selling direct, should, ironically, lead to elevated growth rates post-pandemic for best-in-class sporting goods retailers, like Academy, that are able to keep buying from the top brands. While some of the world’s most powerful brands like Nike and Adidas are certainly investing in bringing consumers to their own shops and e-commerce sites, the need for some third-party retail partners that can offer them access to consumers they can’t reach via DTC will never go away.

The move to direct by the brands is therefore a nuanced one, as the brands aren’t completely pulling out of the wholesale business; instead, the move is an attempt to capture more of the high-value sales internally, clawing back share from retail partners when it comes to expensive, high-fashion content items, like Jordan, Air Force One, and Yeezy sneakers.

Those products differ from the more moderately priced family basics where sporting goods retailers, like Academy, specialize. But since Nike and Adidas want to push people into their owned retail outlets and digital offerings, they are pulling out of smaller and weaker wholesale accounts.

The brands stepping away from smaller chains is bad news for the consumer who wants to try on products from these brands but doesn't live in a big city where they operate stores. There are plenty of consumers who prefer in-person to e-commerce, especially in footwear, and even more so in kids' footwear – and the number of locations to shop in-person for athletic footwear from the top brands has been reduced and will likely continue to reduce further.

While Nike and Adidas pulling back from smaller chains is crippling for the chains that are cut off, those that survive should thrive, as traffic that once went to those weaker wholesalers is diverted to the strongest.

And given the size of Academy, it should be one of the last retailers standing for customers who want access to Nike and Adidas products in a physical store, without driving long distances.

When it comes to Nike, we are even more bullish on Academy maintaining this relationship, as industry contacts point to Hicks and former Nike Consumer head, Elliott Hill, being notoriously tight. While Hill did leave Nike in the fall of 2020, we feel Academy should still benefit from this previous relationship, as well as Hicks’ past at Foot Locker, Nike’s largest wholesale account in the U.S.

With Nike already reducing its wholesale accounts by 50% in North America, the pickup in traffic for stores like Academy is already here and will continue for years to come, driving above-trend growth.

Turning to the risks and opportunities presented by e-commerce, we think Academy’s status as an omnichannel player should drive growth in the future for multiple reasons.

First and most importantly, online-only stores can't fulfill a customer’s immediate needs.

If the spring season rolls around and your kid has a game scheduled and you find he has outgrown his cleats from the fall, you have to go into the store to get new ones because the need is urgent. Even with more lead time, lots of people like their kids to try on shoes in the store so they know they will fit. 

Second, there is some volatility with shipping to the home. It’s obviously really inconvenient for consumers when delivery is delayed, and this is happening with higher frequency these days due to the well-publicized challenges to the supply chain.

Finally, sometimes shopping in person can just be fun - whether it’s picking out a new fishing pole, sneakers, or finding a new pair of leggings that fit just right.

We are bullish on e-commerce – there is no doubt that more sales will migrate online over time. But we also believe that physical stores will continue to play a key role in the future too, for sporting goods, and for retail more generally. So, those with a great online and brick-and-mortar offering should thrive.

We aren't alone in believing in this thesis either, as Alphabet's chief business officer, Philip Schindler, on the company's most recent earnings call stated:

We've seen explosive growth in digital over the last 20-some months. But as the world begins to reopen, shoppers are returning to stores. Brick-and-mortar isn't dead. Instead, omnichannel is in full force. Searches for "open now near me" are up four times globally versus last year.

Strong growth in local shop queries means people [are researching] their visits to stores more often before they go. As a result, we've seen more advertisers include in-store sales alongside e-commerce goals to drive omnichannel growth. Adoption has nearly doubled over the past year...

Putting the three trends together – consumer preference shifting towards the outdoors, the brands shifting to direct and consolidating retail accounts, and the superior customer shopping experience offered by omnichannel - leads us to believe that the sales levels that sporting goods retailers have seen in the last two years are not only sustainable, but that growth will be above the pre-pandemic trend (but below pandemic levels, obviously).

Company-Level Thesis on Academy

We like Academy the most out of the current sporting goods retailers because the company has low hanging fruit to pick operationally, and its current CEO, Ken Hicks, is the right man to execute on this opportunity. 

Academy, in 2019, was able to lure Hicks out of retirement, which was a major coup.

Over the course of his five-year tenure at Foot Locker, from 2009 to 2014, Hicks was able to boost Foot Locker’s share price by 5x, despite shrinking stores by 3%.

During his time at Foot Locker, sales rose 35%, profits quadrupled, and shares outstanding were reduced by 10%. 

While Foot Locker’s topline clearly benefited from the overall economic rebound after the Global Financial Crisis, the much bigger jump in profits was driven by Hicks implementing a number of changes at the store-level, such as reducing the amount of inventory each store carried, which led to more full-price selling, better margins, and higher returns on capital.

Over this time period, sales per square foot at Foot Locker rose more than 40% above the previous high set in 2007. 

Hicks also culled underperforming stores, and kept corporate costs in check, driving margin improvements. 

Given the parallels between Foot Locker and Academy, we think that Hicks is the perfect man for the job.

Hicks is also well-incentivized to turn Academy around, as he owns $17 million worth of stock today, and another $30 million or so, as of this April, that is yet to vest.

His efforts to sharpen Academy operationally are clearly already working after three years on the job, as gross margins have moved up meaningfully.

While the strong macro environment is surely helping Academy, we believe that the improvements implemented by Hicks and his team mean that Academy’s results are more sustainable than peers – and that there are many more operational levers left to pull that will drive growth and margins higher in the coming years.  

An example helps to elucidate the types of changes Hicks is implementing...

For a long time, Academy tried to have the best price, by a wide margin, on everything in the store. The company was sharp on price, even on products where it didn't have to be.

Academy would offer a fishing shirt made by its private label brand, Magellan Outdoors, at the lowest price available in the market. While presented at an unbeatable price, it was also a high-quality product, offering exceptional value, which the customer easily recognized.

The incredible price and value offered by its private label products are a major reason that customers are loyal to Academy. Private label goods account for around 20% of Academy sales and are inexpensive, functional, and durable.

But Academy has historically applied that same aggressive value pricing strategy to higher-priced national brands – like a Columbia fishing shirt.

But they really didn’t need to do this, as customers looking to buy a more expensive model of a given item are often less price-sensitive and more willing to pay the manufacturer's suggested retail price for branded items.

By not discounting higher priced national brands, Academy gets a sales and margin uplift – without impacting customer loyalty.

Beyond the more disciplined pricing strategy, Hicks has Academy stores running leaner on their inventory – just like he did at Foot Locker. He is also looking at opportunities to diversify Academy’s supply chain and pursue lower sourcing costs and, in some cases, faster speed to market.

And looking forward, Hicks will continue to focus on streamlining the merchandise planning process and getting more precise with ordering goods to match demand; improving the localization of merchandise - like selling more lacrosse equipment in North Carolina or more beachwear in Florida; and improving labor management systems, like allowing co-worker friends to work together, improving retention, or reducing the number of representatives in store at non-peak hours.

We’re sure that there are many more areas of potential cost savings beyond the ones listed above, but the sheer number of simple things that can be done to improve the stores give us confidence that internal improvements should drive the business, and stock, higher for years to come.

And when it comes to the online business, Academy has even more low hanging fruit to pick as it is really just getting started.

Although it already accounts for 10% of sales today, Academy only launched a mobile app in July. Academy is playing catch up here – but the early results are promising.

Given Hicks' track record of identifying and capitalizing on incremental in-store operational improvements for years at Foot Locker, we do not doubt that he'll continue to make Academy a more efficient operation for years to come – both in stores and online.

Why Now?

Fundamentals

We believe that much of the recent 20% drawdown is due to investors expecting comps to go in reverse in 2022.

While comps will likely slow down, we don’t expect them to plummet. We think Academy’s improved omnichannel offerings, as well as a strong inventory position for spring, could even drive a stronger 2022 than 2021.

Academy’s core markets – the Deep South and Southeast – have already functioned as if we were essentially post-pandemic since the third quarter of 2020, so in some ways – 2021 was the “post-pandemic, tough comp year” for Academy. The fact that life has been operating pretty normally for over a year in its home markets limits Academy’s forward risk from a possible spending shift from goods to experiences in 2022. Simply put, the world has been fully reopened in Academy’s markets for a long time now.

We think that the company posting 18% comps in the third quarter, after growing comps 24% in 3Q20 is a great sign, as was its 6% sales growth in 2Q21 on top of the stimulus-fueled 2Q20 when comps were 28% . These results indicate to us that current sales levels are sustainable for Academy, making a broader reopening, a minor, rather major, headwind for Academy.

Beyond the broader reopening, in 2022, Academy may also face another minor headwind from declining sales from lower end customers, who have now blown through their stimulus checks and/or supplemental unemployment benefits and may have to return to paying student loans. This risk is at least partially offset by the higher wages being seen at the low end of the labor market..

We feel that Academy’s 2022 headwinds are real but relatively minor, rather than the major ones that investors expect when they price the stock at under 6 P/E. Our expectation for 2022 comps is for them to be flat, if not slightly positive – something management alluded to on the most recent earnings call – as these minor headwinds are offset by either the internal or macro tailwinds we discussed earlier.

Second, there may be worries that, like with any retailer still posting strong online comps in 2021, a reversion will occur in 2022.

Academy however only launched its mobile app in July 2021, setting its online business up for easy comps for the next three to four quarters.

This means that even if desktop online sales decline in 4Q21 through 4Q22, as Academy faces difficult pandemic comps for e-commerce, the launch of the mobile app (along with other improvements to Academy’s online business, which is only three years old) should help e-commerce “comp the comp” in 2022.

We do acknowledge that the mobile app launch may turn into a headwind, likely in the last quarter of 2022, but that is far into the future.

Lastly, inventory is in a far better shape at Academy today than last year – specifically, when it comes to hardgoods like bicycles.

While Academy has done an excellent job staying in-stock for the last year, they still have struggled to stay in stock in the most in-demand hardgoods items. This will change in the spring of 2022, as management noted that inventory should be back to normal by then for all goods.

This improving inventory situation is however not unique to Academy, and, when combined with easing supply chain concerns, there are worries that heavy or excessive promotions could return this spring as retailers look to clear inventory that arrived months late.

We believe this is unlikely to meaningfully impact Academy, as most of the inventory that will be marked down materially will be seasonal – like winter coats – but given its presence in the south and the nature of sporting goods, seasonal merchandise is more limited at Academy than at many other retailers.

We still wouldn’t be surprised to see margins come under some pressure because of an increase in promotions this spring – along with a mix shift towards hardgoods and Academy’s planned opening of eight to ten stores.

Putting this all together, we think it’s possible to see Academy grow comps in the low single digits, overall sales in the mid-single digits, and see margins come under some slight pressure due to the mix shift and store opening expenses. We get to EBITDA of just under $1 billion for 2022 – well above consensus of around $900 million.

Capital Allocation

When asked about possibly returning cash to shareholders on the second quarter earnings call in September, Hicks plainly stated that the company wasn’t planning on instituting a dividend for the foreseeable future given how cheap the stock is. This was when the stock was at $43.52. With more visibility on supply chain – and 2022 – we expect that this remains the case, if not more so, given the stock is now almost 10% lower.

Academy will likely produce more than $800 million in free cash flow over the next five quarters and has a clean balance sheet. With a stock that management (and we) believe is cheap, we expect share repurchases to be meaningful in the next year, providing support for the stock 

One major overhang on ASO shares since the IPO was large ownership by KKR, which still owned 40% of Academy shares post IPO. This overhang has subsequently been removed… KKR sold the rest of its ASO shares in two separate block trades. During the second transaction, Academy bought half of the block, reducing share count by 5% - an indication of how bullish management is on the business.  

We think the high cash generation, a willingness to buy back shares, a proven moneymaker of a CEO, and a relatively unknown stock that is fairly new to the markets is a compelling set up.

Valuation

The stock is trading at just over 4x estimated EBITDA for calendar 2022, <7x calendar 2022 estimated EPS, and at a trailing twelve-month free cash flow yield in the low double digits – despite having an inventory swing of $250mn suppressing trailing twelve-month free cash flow.

Clearly, the stock is priced for little to go right, when, as we’ve outlined, there are multiple ways to win.

In our base case scenario, we see comps in the 0%-1% range both in 2022 and 2023. We expect Academy will add 18 stores in this scenario, driving sales to a touch over $7 billion in 2023. We expect 2023 gross margin of 35.2% - slightly below expected 2021 levels – due to mix shift towards hardgoods, a more normal supply chain, and higher promotional environment, partially offset by internal improvements. We then believe SG&A can leverage slightly over 2021 levels to 20.8% (60bps), as store opening expense offsets some of the improvement in operational efficiencies realized by Hicks and team. We don’t expect meaningful deleveraging from the store expansions, as Academy is mostly looking at filling in regions, rather than expanding into new ones. Putting it all together, we think calendar 2023 EBITDA can hit $1.130 bn (versus the street around $950 million).

With inventory normalized in the spring of 2022, cash flow should be meaningful in 2022 at more than $650 million. We expect that Academy will use the cash flow to reduce its share count by 10mn (roughly $400 million at today’s price of $40), as well as retire its 6% 2027 debt (principal $400 million),.We think shares should be worth nearly $80, when using an “out of the dog house” EBITDA multiple of 6, providing us a double in one years’ time.

In a bull case scenario, we think ’22 and ’23 comps could come in a bit hotter in the 2%-3% range and that Academy opens 20 stores, leading to sales of $7.3 billion in 2023. 2023 gross margins would expand by 40bps relative to 2021 to 36.0%, as operational improvements offset more promotions and mix shifts. We then expect the sales boost to leverage SG&A by 100bps to 20.2%, leading to EBITDA of a touch over $1.3 billion in 2023.

In this scenario, we expect nearly $900mn in FCF in 2022 and 4Q21, leading to buybacks that reduce share count by more than 12 million shares. This still leaves the cash balance at more than $900 million – more than ample to pay down the 6% debt due in 2027 with principal of $400mn, should they choose, or pay a special dividend like Dick’s did this year. We’d expect a multiple of 8x, at the low end for historical “good” box growth stories, leading to a 2022 year-end PT of roughly $120.

On the flipside, if we are wrong and the comp bears are right, and 2022 pans out to be a more difficult year, we expect comps to decline in the high single digits before rebounding 2% in 2023, leading to 2023 EBITDA of just over $800 million. Share repurchases of just 4mn in this scenario lead to a cash balance of $615mn by year end 2022. With worries about Academy getting disrupted by online and offline competitors, we think a 5x multiple would be warranted, leading to a flattish stock.

To us, this seems to be a heads we win, tails we break even situation. The currently depressed valuation offers a high margin of safety, while realization of the worst-case scenario seems unlikely given the micro and macro tailwinds and a proven winning jockey at the helm of Academy.

Risks 

1. Consumer spending slowdown

2. Consumers start spending more on travel and experiences, funding this with lower purchases of goods

3. Failure to execute / Hicks departs

4. An overly promotional environment emerges post-supply chain constraints

5. Loss of brands

Catalyst

1. Buybacks in 2022
2. Positive comps in 2022
3. Margin expansion as the operational restructuring continues