Academy Sports and Outdoors (ASO) has gone public and while the company enjoys great operating momentum since the Covid-19 outbreak, investors are very cautious on the prospects for the shares despite these circumstances.
Investors seem to recognize that the company still torches along some debt and is not the strongest player in a very competitive field, with investors arguably cautious on the prospects if the conditions ‘”normalize.” I recognize that shares look cheap, yet have the same concerns, as I am not automatically buying the softness following the offering.
Sports and Outdoors
Academy Sports and Outdoors was founded in San Antonio more than 80 years ago and ever since has expanded into a sports and outdoors emporium through its focus on customers, assortment and value. The company has 259 stores across 16 Southern states, offering ”fun for all” through a localized merchandising strategy in outdoor, apparel, footwear and sports & recreation. Besides localized offerings, the company distinguishes itself through a combination of own and national brands offered for sale as well.
With an average size of 70,000 square feet, the stores are quite large as the company has more than 20,000 team members. The stores remained open during the Covid-19 pandemic, actually creating a boom to the results so far this year. The range of equipment and products being sold is very wide, including fishing gear, tents, barbecues, apparel, various kinds of shoes, bikes, etc.
Truth be told, just like the wider industry the company has been seeing a few challenging years with negative comparable sales trends. The company is owned by private equity giant KKR which bought the business back in 2011. Given that this owner owns the business for nearly a decade already, far longer than the typical time frame of a private equity firm, it is quite obvious that the deal has not worked out as anticipated. The usual recipe of leveraging up the balance sheet alone has not proven to be a winner.
IPO and Valuation Thoughts
Academy Sports and its underwriters aimed to sell 15.6 million shares in a price range between $15 and $17 per share. Despite operating in a hot market at this point in time, pricing was cut to just $13 per share, as the company still generated $203 million in proceeds in connection to the offering.
With 88.1 million shares outstanding, the equity value of the company totals $1.14 billion at the offer price as shares have been fluctuating around this level ever since. With the business controlled by KKR, the company was saddled with debt, in fact it operated with net debt at $1.3 billion in February of this year. Net debt is seen around $800 million upon closing of the offering, which is equivalent to about 2.5 times leverage based on $322 million in adjusted EBITDA reported for 2019.
Leverage ratios will drop a great extent after a very strong first half of the year as EBITDA for the first six months of the year already comes in at $283 million, nearly equal to all of 2019’s performance. Based on this net debt load, the entire business is valued at nearly $2 billion.
Truth be told that the retailer is quite a large operator, yet it has seen some challenges. The company grew sales from $4.6 billion in 2015 towards $4.8 billion essentially for 2017/2018 and 2019 now. Lack of real growth made that slim margins remain very slim. The company reported an operating profit of around $250 million in 2015, and after trending around $150 million in the years which followed, this came in at $180 million in 2019 (the fiscal year ending February 2020). The problem is that of the underlying economics as the company has reported negative comparable sales for four years in a row, combined adding up to more than 10% over these years, with flattish sales only held up by new store openings.
With net debt around 2.5 times 2019 EBITDA, I peg interest costs at around $40 million on the back of a 5% cost of debt. Assuming a 20% tax rate, I peg net earnings potential at $112 million based on 2019 numbers, working down to earnings power around $1.25 per share.
This multiple does not sound very demanding at 10 times earnings, and like many outdoor retailers the company has seen a big boom so far this year despite, or better said thanks to Covid-19. After all, sales are up 18% so far this year as the $428 million increase in sales made that operating earnings more than doubled to $198 million, with operating earnings so far exceeding the 2019 results! Hence, the company might easily earn a dollar or two per share, or even more than this, for the year 2020. This would translate into a very non-demanding earnings multiple.
Truth be told that Academy Sports and Outdoors does not strike me as a very strong business after 4 years in a row of negative comparable sales growth. Moreover, the company carries quite some debt, is owned by private equity longer than its owners would like to see, and e-commerce is underdeveloped. Furthermore, the company relies largely on Chinese imports, creating not only a risk in relation to Covid-19 as the trade war is still going on in the background as well.
The owner took this window of opportunity, ironically created by Covid-19, to take the company public. While the 2020 earnings could be spectacular and thus translate into a very low earnings multiple, I am still cautious.
This is driven by the inherent weakness of the company and to compare apples with apples I look at the 2019 results for this company and some peers. For the year 2019, the company generated $180 million in operating earnings on $4.8 billion in sales, while supporting a $2 billion enterprise valuation. This is equivalent to approximately 11 times operating earnings and 0.4 times sales. The company names quite a few competitors and some peers, including DICK’S Sporting Goods (NYSE:DKS), Big 5 Sporting Goods (BGFV) and Hibbett Sports (HIBB).
DICK’S generated $8.8 billion in sales in 2019 on which operating earnings of $375 million were reported, with margins just over 4% largely in line with Academy Sports. The 89 million shares now trade at $60, for a $5.3 billion equity valuation. The company hardly held net debt by the end of 2019, as the $5.5 billion enterprise valuation valued the operations at 0.6 times sales and 14 times operating earnings. These higher valuations might be supported by better comparable sales trends and somewhat higher margins.
Big Five is a much smaller competitor as its sales come in at just $1 billion and the business was barely profitable in 2019. Hibbett generated $1.2 billion in sales in 2019 and did manage to report operating margins around 3%. With a current enterprise value around $600 million, this values the operations at 0.5 times sales and around 17 times 2019’s operating earnings.
Hence, based on some comparisons, Academy Sports looks cheap but if the Covid-19 boost fades, it still reveals a business which is facing a tough competitor environment, not looking as the strongest player in its field in my opinion, while still operating with net debt (unlike peers). Furthermore, the reality of an anticipated economic slowdown (post Covid-19) is still to be felt.
Hence, shares are an easy avoid for me at this point in time although this might all change if price discrepancies increase even more.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.