One of the more interesting questions in the market is whether there’s value in brick-and-mortar retailers. Within that sector, Dicks Sporting Goods Inc (NYSE:DKS) is one of the more intriguing stocks. Dick’s stock remains rather cheap: it now trades at less than 11x the midpoint of 2018 guidance delivered with DKS earnings on Tuesday morning. At the same time, mounting evidence suggests that DKS stock should be cheap, and maybe even cheaper.
Indeed, as I wrote last week, Dick’s stock is the quintessential retail stock.
That’s not necessarily a compliment. Rather, the challenges facing Dick’s line up almost perfectly with those facing the retail space as a whole. DKS earnings for Q4, which have pushed DKS stock down over 4% in early trading, show the company isn’t up to those challenges yet.
That may change in the future, but until then, investors should ignore the headline multiple and avoid Dick’s stock.
DKS Stock: Q4 Earnings
As far as Q4 earnings go, the news actually doesn’t appear too bad. Revenue of $2.66 billion rose 7.3% year-over-year, though the figure was nearly 3 points below consensus estimates. Same-store sales fell 2%, in the ballpark of the company’s guidance.
News on the bottom line was a bit better. Adjusted earnings-per-share of $1.22 was 2 cents ahead of Street estimates, and toward the high-end of a guided $1.12-$1.24 range. CEO Edward Stack said in the Q4 release that “margins remained under pressure, however the decline was less than we anticipated.”
Expectations aside, however, the quarter doesn’t seem all that strong for Dick’s stock. Non-GAAP EPS still declined over 7% year-over-year. Backing out a 9-cent benefit from the fourteenth week in the quarter, per the Q4 release, DKS earnings would have dropped over 14% on an adjusted basis. And with the benefit 4-cents higher than guided on the Q3 conference call, the bottom-line beat doesn’t look quite as impressive.
The bigger concern appears to be fiscal 2018 (ending January 2019) guidance. Dick’s is guiding for EPS of $2.80-$3.00, which is above consensus of $2.77. But that consensus figure looks deflated by the fact that some analysts haven’t updated their models for the effects of tax reform. Dick’s is guiding for an effective tax rate of 26% this year, against 35.5% in FY17. That alone should provide a 15% boost to earnings.
More broadly, backing out the 53rd week a year ago, FY17 EPS dropped 6.5%. Excluding that week and tax help, the midpoint of guidance suggests another ~13% decline in FY18. Given debt on the balance sheet, plus over $3 billion in operating lease commitments, a declining business doesn’t sound particularly attractive, even at a barely 10x forward EPS multiple.
What Fixes DKS Stock
The problem for brick-and-mortar retail as a whole doesn’t just come down to business being taken by Amazon.com, Inc. (NASDAQ:AMZN). But e-commerce pressure overall is a real problem — as Dick’s management has admitted. It hits retailers up and down the earnings statement — as seen clearly in Dick’s own numbers.
First, same-store sales have slowed across the board. Part of the issue is pricing pressure. For Dick’s, liquidation sales at bankrupt competitors like the Sports Authority likely have taken some sales. Amazon and other online rivals have as well. But — all else equal — retailers generally need 2%+ same-store sales at least simply to leverage labor and rent expense. Dick’s posted a negative 0.3% comp in FY17, and is guiding for flat-to-negative same-store sales in FY18 as well.
That’s simply not good enough.
Add to that margin pressure. Adjusted gross margin declined 130 bps in FY17; it’s guided to fall again next year. Pricing pressure continues to be intense, and with online shopping making price comparisons clear, that’s unlikely to abate. Dick’s did manage to leverage SG&A for the full year, but costs crept up in Q4, and investments in ‘omnichannel’ shopping will hit FY18 margins as well.
So the problem facing Dick’s, and DKS stock, at the moment is clear. Sales need to get better … and so do margins. The current trajectory just isn’t good enough.
Dick’s Stock Isn’t Cheap Enough
And it can get worse for Dick’s stock in the meantime. A 10x+ EPS multiple might sound cheap, but Hibbett Sports, Inc. (NASDAQ:HIBB) trades at under 10x, excluding its cash; Sportsman’s Warehouse Holdings Inc (NASDAQ:SPWH) trades at 7x. A single-digit multiple for a declining business isn’t unusual, and right now Dick’s is a declining business.
Meanwhile, I’m skeptical of a turnaround. Margin pressure is unlikely to abate. Nearly one-third of FY16 revenue came from Nike Inc (NYSE:NKE) and Under Armour Inc (NYSE:UAA, NYSE:UA). Both of those companies are trying to build out their own DTC businesses — Nike in particular. And I’m not sure sporting goods itself is a strong sector longer-term, given declining participation rates among youth.
A 10x EPS multiple and a nearly 3% dividend yield might sound attractive. In the case of DKS stock, however, they’re not quite enough. Business has to get better, and until Dick’s shows some signs of progress on that front, DKS stock remains an avoid at best.
As of this writing, Vince Martin has no positions in any securities mentioned.
