Description

Investment Summary

I am long Hibbett Sports (ticker: HIBB, “Hibbett” or “the Company”), which is a sporting goods retailer with 1,000 stores in small and mid-sized markets primarily in the South, Southwest, Mid-Atlantic, and the Midwest regions of the U.S. A good opportunity exists today to buy HIBB well. The Company’s share price is at its lowest level since 2011 and the Company’s trading multiples are at their lowest level since 2009. Purchasing HIBB today can result in investors receiving a ~10% annual return for the next ten years based on fairly conservative assumptions. HIBB is attractive because it offers a great risk-reward opportunity as the Company has good growth prospects and industry-leading margins but is trading cheaply relative to other retailers within the sporting goods retail space, which as a whole has seen its multiples contract along with several other types of retailers within the broader U.S. retail industry, while premium retailers in certain segments such as home improvement (HD, LOW) have seen their multiples expand recently, a divergence some believe is now overdone. In an expensive market, buying retailers like HIBB with minimal debt, strong brands and good growth prospects (in other words several years until they hit their store maturity level) and which are trading cheaply  could result in attractive returns in the long-term (for this reason I also like ROSS). I don’t necessarily have a view on how Q2 earnings, which are announced tomorrow, will turn out. This is more of a long term idea that I think can result in good (albeit modest) returns with the potential to outperform the broader market in the next 5-10 years.  

Earnings Pre-Announcement

Ten days ago HIBB partially pre-announced Q2 earnings, which were below the Street’s expectations and resulted in the stock falling nearly 10%. HIBB stated that Q2 sales were up 2.8% but same store sales were down 1.1%. Q2 2015 EPS was revised to $0.26-$0.28 versus $0.32 for Q2 2014. The CEO stated that “while we anticipated slower sales due to 10 states delaying their tax-free weekend by one week (from the last weekend in fiscal July in the prior year to the first week of fiscal August this year), there also was underlying business softness.” The “underlying business softness” is the phrase that scared investors. Tomorrow we will learn more about what exactly is causing the softness. I suspect it is more related to the general sporting retail environment rather than company-specific issues which the market seems to think could be the case. HIBB is not alone in the space. For example, the share price of one of HIBB’s other competitors Big 5 Sporting Goods (ticker BGFV) fell nearly 30% upon management recently lowering their outlook for the company’s store growth. Note that in the last five quarters, HIBB beat the Street’s EPS estimates four times.

Company Overview

HIBB was founded in 1945 and is based in Birmingham, Alabama. The Company currently has 1,000 stores that offer a range of merchandise, including athletic footwear (52% of sales), team sports equipment (24% of sales), and athletic and fashion apparel (24% of sales). HIBB also sells merchandise directly to educational institutions and youth associations. The primary store format is Hibbett Sports, a 5,000-square-foot store located in strip centers (80% of total) and enclosed malls (20% of total). Having the majority of stores located in strip centers increases visibility compared to stores in enclosed malls, which is important given mall traffic appears to be in a secular decline. With respect to brands, HIBB sells the premier brands. For example, Nike products represent a large percentage of HIBB’s sales. Relative to its peers, HIBB has good diversification across states (no state represents more than 10% of the total store count). The three states in which HIBB has the most stores are Texas, Georgia and Alabama with 97, 97 and 90 stores each, respectively.

New store economics are attractive. For a typical 5,000 square foot store, the initial investment is $200,000 (includes fixtures, leasehold and net inventory). Year 1 sales are around $725,000 with a store contribution of $116,000 (includes depreciation), resulting in a 16% store contribution margin. By year 5, the total investment is $225,000, sales are $950,000 and store contribution is $209,000, resulting in a 22% store contribution margin. Management believes they can grow the store base to 1,500+ stores. In recent years they have opened around 50 stores net each year. At this rate, they will reach 1,500 stores in 10 years, which I assume in my valuation below.

Industry Overview and Discussion of Peers

The sporting goods industry is a $67 billion market that is highly fragmented and competitive. Dick's Sporting Goods (ticker DKS) is one of the largest players with a 10% market share and 7x the sales of HIBB, implying HIBB has roughly a 1.4% market share. BGFV is another competitor of HIBB. DKS’ stores are larger at an average of 46,000 square feet per store vs. ~5,000 for HIBB and 12,000 for BGFV. HIBB’s stores are smaller as the Company focuses on smaller and more mid-size markets where management believes the markets are more attractive and a competitive advantage can be obtained.

HIBB sells both sporting goods for players as well as fans. Players can further be separated into competitive players and leisurely players. For competitive players, having the right fit for both footwear and apparel is extremely important to ensure the best performance possible. I think having the right sized footwear is perhaps the most important (one could play with a slightly oversized jersey but playing with shoes too big would be much more difficult). Having the right equipment is also important. Half of HIBB’s sales come from footwear, which is a much higher percentage than DKS and BGFV and should help reduce the impact of online retailers taking sales from HIBB (unless someone tries on a shoe at HIBB and then buys it online from someone else for cheaper). I imagine buying equipment online can make more sense than buying footwear. Overall, because fit matters for sporting goods, it’s important that players try them on before buying. Furthermore, going to a physical store and buying all of one’s sporting needs for the season that same day (for soccer this would include cleats, socks, shin-guards, shorts and jersey) is optimal to buying online from several different stores and waiting for the goods to arrive, especially if the first game of the season is right around the corner. Online stores often do not have all sizes available at any given time.

HIBB thinks they can get to 1,500 stores from 1,000 today. Some of the new stores will continue to be in small and mid-sized markets where HIBB has a niche. Others will likely be located in larger, more competitive markets. Small towns are good places to operate not only because competition is less, but also because many small towns thrive on sports. Parallels could be made to the newspaper industry for which Buffett predicted small town newspapers would not suffer the fates of larger newspapers given the former are critical containers of community-specific news which cannot be obtained elsewhere and is therefore valued.

In its smaller niche communities, HIBB is able to establish greater customer, vendor and landlord recognition as a leading sports retailer. HIBB does well with the depth of its product relative to competitors in small markets, many of whom are mom and pop shops. In HIBB’s markets, there has historically been low competitive overlap with big box competitors. HIBB has specialized in small towns where the big-box retailers don’t have a presence due to there not being enough demand for their large store formats, although it’s worth noting that some of the big-box retailers, in order to grow, are experimenting with smaller store formats to compete in smaller markets.

DKS is a competitive threat as it has identified Texas, California, Florida, and New York as stores where it can open up more than 25 new stores in each state. Note HIBB is only in Texas and Florida, so DKS expanding its store base in California and New York will not affect HIBB (note HIBB has no plans to expand into California or New York). HIBB does expect to expand its store base in Texas and Florida, which could face more competition should Dick further penetrate these markets.

DKS is targeting 735-750 total stores by end of 2017, opening 45-55 a year (excludes Golf Galaxy and Field & Stream stores). As discussed below, DKS currently trades at a premium to HIBB, even though the two are opening up new stores at a similar rate and HIBB has higher margins. That said, one reason I think DKS should trade at a slight premium to HIBB is that DKS has a better online platform and presence. DKS’ eCommerce sales are 8.5% of total sales, up from 2% not long ago. HIBB does not disclose its eCommerce sales, but I suspect it is likely much lower than 8.5% as the Company has been slow to develop its online platform, which it is currently working on and which could serve as a catalyst should its build-out occur sooner and more effectively than expected. Another issue that has affected HIBB but not DKS is that some customers have been coming into HIBB stores and not getting their desired size and color of product. The Company’s point-of-sale (POS) project, which it has already invested in, should resolve this issue in the coming quarters and could act as a catalyst for higher earnings.

• Below is a comparison of key metrics for HIBB and the two other closest competitors in the space, DKS and BGFV:

• SSS growth

• HIBB had SSS growth of 9.8% in 2010, 6.8% in 2011, 6.9% in 2012, 1.8% in 2013, 2.9% in 2014, (0.9%) in Q1 2015 and (1.1%) in Q2 2015

• Relative to peers, HIBB had the greatest SSS growth in the 2010-2012 period

• HIBB had similar SSS growth relative to peers in the 2013-2014 period

• HIBB has lagged peers so far in 2015, however perhaps this is not as negative as it appears given HIBB grew faster than peers in prior years (hence one could argue the peers have caught up to HIBB with their recent growth)

• DKS had SSS growth of 7.2% in 2010, 2.0% in 2011, 4.3% in 2012, 1.9% in 2013, 2.4% in 2014, 1.0% in Q1 2015 and 1.2% in Q2 2015

• Note DKS’ SSS growth includes eCommerce sales, which are now 8.5% of total sales. Without eCommerce sales, DKS’ SSS growth would not have been as strong

• BGFV had SSS growth of 0.8% in 2010, (1.2)% in 2011, 2.5% in 2012, 3.9% in 2013, (2.9)% in 2014, 3.9% in Q1 2015 and 1.7% in Q2 2015

• Sales mix

• HIBB: 52% from footwear, 24% from apparel, and 24% from equipment

• HIBB sells the most footwear and the least equipment

• DKS: 19% from footwear, 36% from apparel, and 44% from equipment

• BGFV: 28% from footwear, 19% from apparel, and 53% from equipment

• Sales per square foot

• HIBB has 5.7 million square feet, implying sales per square foot of $161

• HIBB is lower than peers likely due to peers selling relatively more equipment which commands a higher sale price

• As a result, I’m not sure one can argue that HIBB could reach the sales per sq. ft. of its peers (unless a product mix shift was to be implemented or other fundamental changes to the business were made)

• DKS has 35.1 million square feet, implying sales per square foot of $201

• BGFV has 4.8 million square feet, implying sales per square foot of $208

• Forward trading multiples

• HIBB: 6.0x 2016E EBITDA and 12.6x 2016E P/E

• DKS:  7.0x 2016E EBITDA and 15.0x 2016E P/E

• BGFV:  5.6x 2016E EBITDA and 12.3x 2016E P/E

• LTM trading multiples

• HIBB: 6.6x EBITDA, 14.1x P/E

• 10 year average of 10.6x EBITDA and 21.5x P/E

• Current trading levels represent an EBITDA multiple discount of 38% and a P/E multiple discount of 34% relative to the 10 year respective average

• HIBB is currently trading at its lowest multiples since 2009

• DKS: 8.2x EBITDA, 17.8x P/E

• 10 year average of 9.2x EBITDA and 22.2x P/E

• BGFV: 6.3x EBITDA, 16.5x P/E

• 10 year average of 6.7x EBITDA and 15.3x P/E

• Store growth

• HIBB has recently been growing its gross store base by 8% annually

• DKS has recently been growing its gross store base by 8% annually

• BGFV has recently been growing its gross store base by 4% annually

• Given their higher growth, HIBB and DKS should trade at a premium to BGFV

• EBITDA margins over last several years

• HIBB: 11-16% range (14% most recently)

• HIBB has a 36% gross margin

• DKS: 8-11% range (11% most recently)

• DKS has a 31% gross margin

• BGFV: 4-6% range (5% most recently)

• BGFV has a 32% gross margin

• Given HIBB’s significantly higher margins, HIBB should trade at a premium

Based on these metrics, I believe HIBB should trade at a premium to BGFV, whose operating performance and margins have historically been volatile and whose growth prospects are not as attractive. In addition, BGFV’s balance sheet is not as clean as HIBB’s. I believe HIBB should trade at a discount to DKS, given the two have similar growth prospects but DKS has a better online platform and has posted stronger SSS results this year. HIBB should trade closer to DKS and less so to BGFV. I think HIBB deserves to trade at a discount to the ~10x EBITDA multiple the Company traded at in recent years stemming from the strong growth coming out of the recession which will likely not be the same going forward. Nonetheless, I believe the current 6.0x forward trading level is too low and a 6.5-7.0x forward multiple is more appropriate, the high end of which is where DKS is currently trading. Similarly, HIBB should not be trading at 12.6x forward P/E and should instead trade closer to 14x, which is still below DKS’ 15x level.

Capital Allocation

Management is a good allocator of capital. The majority of free cash flow goes towards organic growth and shareholder-friendly activities like share repurchases (note HIBB does not pay a dividend). Management does not make acquisitions. The Company has had minimal debt for several years and has good liquidity with $119 million of cash on the balance sheet (management has said they would like to keep a minimum of $50 million in cash) and $80 million available under the revolving credit facility. During Q1, HIBB repurchased 200,000 shares for $10 million and still has $166 million left under the current authorization program. In the last three years, HIBB has bought back $118 million of its stock, or 12% of the Company’s market capitalization. Management owns 1% of the Company.

Valuation

Management thinks that at the Company’s maturity HIBB will have 1,500+ stores. Assuming HIBB gets to 1,500 stores from opening 50 stores net a year (largely consistent with 2013 and 2014 growth), HIBB will get to 1,500 stores in 10 years. Conservatively assuming that at maturity HIBB keeps its 14% current EBITDA margin and assuming each store will do $950,000 in annual sales (consistent with current performance), HIBB will have mature EBITDA of $199.5 million (vs. $133 million today). Applying a 7.0x mature EBITDA multiple results in an enterprise value of $1,397 million at maturity. Assuming each new store requires a $200,000 investment means opening 500 stores will require $100 million in capex. Assuming a 9% levered free cash flow margin (10% margin from cash flow from operations less 1% for non-new store capex) results in cumulative levered free cash flow over the next 10 years of $1,091 million. The Company currently has $119 million in cash and $3 million in debt, or net debt of negative $116 million. Taking the forecast enterprise value in 10 years of $1,397 million, subtracting net debt of negative $116 million and adding cash generated over those 10 years of $1,091 million results in a forecast market capitalization of $2,604 million at maturity, or a share price of $100.15. The current market capitalization and share price are $991 million and $40.25, respectively. Therefore, by buying HIBB today, investors can expect an annual return of 9.5% over the next 10 years, which is a modest but attractive risk-reward opportunity that could outperform the broader market. Note I have conservatively assumed no share repurchases during the next 10 years, which if factored in would boost returns.

Risks

The primary risk is that competition from online and other competitors (large ones like WMT and smaller ones like DKS) could hurt the Company’s earnings and growth. HIBB’s investment in the POS system and online platform may not go as planned. More broadly, consumer spending within the retail sector could be impacted once interest rates begin to rise.

Catalyst

Recent underlying business softness happens to be due to industry trends rather than company-specific issues. Same store sales growth increases in future quarters. Store growth does not slow down. Implementation of POS system and improved online platform are on schedule and result in increased sales. Management takes advantage of the low share price and repurchases shares.