Description

Summary

Dick’s Sporting Goods (DKS) is another post-pandemic structural vs cyclical setup where combo of share price/re-elevated expectations now suggest structural dynamics are overestimated which when combined with increasingly late-cycle cyclical timing makes risk/reward asymmetric to the downside. Thesis suggests slower pace of deceleration/recent stability in highly elevated sporting goods demand has the market underestimating the impact of discretionary spending impulse created by temporary MMT on the category and subsequently the favorable company-specific earnings dislocation. While some sources of structural change here are likely sustainable and thus factor more heavily into post-pandemic scenario analysis vs other beneficiaries, the bet is recent sentiment/narrative boost likely to ebb in favor of renewed concerns this P&L is far from normalized. Resumption of downward revision cycle should put prior lows sub-$80 earlier this year in play as downside uncertainty reasserts itself especially given magnitude of pandemic P&L benefit incl F21 topline +40% to $12.3B and EBIT margins +11ppts to 16.5% vs F19. Primary catalysts are 1/ evidence of weakening category spend and 2/ re-entry into downward revision cycle while normalization overhang should limit further upside since focus should be on F23 EPS power. Risks include 1/ sustained performance at/above expectations which degrades cyclical bear case while supporting continued elevated deployable FCF and 2/ timing of resumption of downward revision cycle as recent evidence of stability offers immediate-term potential for even further multiple re-expansion from current 10x F23 consensus EPS.

Pandemic mean reversion has been a veritable feast for previously starved short sellers since multiple beneficiary categories began to mean revert on varying timelines and to different degrees. Patience/timing has been key since being early even in the most obvious setups has often been painful especially given step-change topline and margin benefits and subsequent FCF generation created by the pandemic boost. Forecasting becomes secondary and flexibility/humility is required once a company does enter the giveback vortex since the range of downside outcomes is extremely wide given how dramatically pandemic-boosted P&Ls look vs pre-pandemic. Valuation also becomes secondary since the market has tended to compress multiples dramatically with F19 baseline often becoming an unreliable anchor owing to pull-forward concerns. With numerous categories having already rolled and driven hefty downward revisions/share-price declines, sentiment surrounding beneficiaries is likely to remain highly fragile and potentially rapidly ebb and flow in the most durable categories such as this one. 

The sporting goods category has been one of the biggest pandemic beneficiaries and is currently viewed as different owing to perceived sticky consumer behavior changes including adoption of healthy habits and migration to outdoor pursuits. Industry structure also appears more favorable including supply destruction and distribution consolidation by large brands most notably NKE. And unlike many other beneficiaries DKS does appear to be a better business vs prior to the pandemic. Effective initiatives including becoming truly multi-channel and enhancing relevancy through BOPIS, differentiated product, vertical brands, more experiential retail focus etc. Admittedly comparisons to a F19 profitability baseline appear overly pessimistic owing to this favorable change. The call isn’t to anchor on a pre-pandemic bear case that incl less-relevant disintermediation and deteriorating profitability concerns that may have largely been attributable to industry disruption. It’s that the stock again appears overpriced on expectations that appear overly optimistic and the consequences for beneficiaries that miss expectations have proven to be harsh.

Given the magnitude of pandemic growth vs historical trend it’s more likely sporting goods are on more of a glide path to normalization where gravity’s just beginning to weigh. DKS still sells want-based discretionary goods subject to waning consumer spending and pull forward. Macro spending headwinds appear well known but investors seemingly want to capitalize the massive benefit from “Go Big!” while heavily discounting any potential lagging impact of policy now attempting to reign it in. As a small business owner it continues to be apparent that post-pandemic spending patterns are still far from what will likely be considered “normalized” in the fullness of time. Ongoing wallet-share shift in favor of services vs goods also still has a ways to run and the handoff has been choppy thus far. Competitive dynamics are worth mentioning incl the potential for much heavier discounting from traditional retailers with assortment overlap. Perhaps less appreciated is a more gradual pace of reversion in consumer behavior incl back toward deal-seeking behavior for example and away from buying whatever was available in an inventory-constrained environment. And a steady albeit slow reversion toward leisure time poverty after a generational transitory boost in free time also seems likely to have an impact on demand in the space. Look for diminished knock-on demand effects from the ongoing work down in big-ticket rec durables backlogs as well.

Sentiment has turned more favorable on better 2Q print/2H relief and of course higher share prices driven primarily by multiple re-expansion. Mgmt continues to assert the bulk of the fundamental improvement is from its transformation initiatives and likely believes the business has rebased owing to consistent 3-year geo SSS in the mid-30s% since the step down in 4Q21. Not surprisingly Street also sees 2022 as a stabilization year and forecasts topline growth to return in F23. DKS trades 10x F23 consensus EPS vs 5-yr avg 12x NTM EPS. On lower F23 estimates 10x would likely represent a ceiling and any weakness even if it ultimately proves transitory would likely dramatically alter sentiment. While scenario analysis is useful for framing, recent precedent suggests that once beneficiary estimates get cut the magnitude of pandemic P&L boost makes forecasting even more of an exercise in guesswork. Flexibility is key but for illustrative purposes a reasonable framework would include $10B revenues or up high teens% vs 2019 and 9% EBIT margins +390bps vs 2019 and equate to ~$7.50 EPS. In a downward revision cycle headed toward <$10 in EPS prior lows earlier this year <$80/share or >30% downside would likely be very much in play. 

Primary risk is sustained performance at/above expectations which further degrades cyclical bear case while supporting cont’d elevated deployable FCF and potential further multiple re-expansion from current 10x F23 consensus EPS.

Thesis 

Post-pandemic normalization incl combo of worse than expected topline deceleration and margin giveback undermine structural arguments and market’s willingness to discount elevated expectations over extended duration.    

Catalysts

Evidence of accelerating category mean reversion. 

Resumption of downward revision cycle.

Fed stays the course.

Risks 

Sustained elevated post-pandemic growth/profitability above expectations.

Timing of resumption of downward revision cycle – among biggest challenges has been ability to retain conviction in categories where cyclical duration is extended.

Bearish positioning incl >20% SI. 

Fed’s bluffing.

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Catalyst

Resumption of downward revision cycle on category mean reversion