Academy Sports + Outdoors ($ASO): Let the Fun Begin
Academy Sports + Outdoors ($ASO): Let the Fun Begin
In a Nutshell
Academy Sports + Outdoors (ASO) is a sporting goods and outdoor recreation retailer.
With a short-term perspective, this is an out of favor sector: consumer discretionary, post-pandemic hangover, supply chain challenges, disintermediation risk, macro-economic headwinds…
Broadening and extending the perspective, this is a thriving company, profitable and generating strong FCF; outperforming its peers; with a robust balance sheet; building a resilient business model; within a growing and rebaselined sector; and with a seasoned new management at the helm.
Ah, and trading at 4x EV/2022E EBIT.
Introduction
Academy Sports + Outdoors (ASO) is a sporting goods and outdoor recreation retailer and I am pretty conscious that nowadays this retail category may be rather out of favor. From a general perspective, there are macro headwinds (coupled with a potential post-pandemic hangover) that make this consumer discretionary sub-sector to be especially risky. Besides there are also other sectorial-specific issues, as the disintermediation risk, that make the sporting goods retailers to be out of the radar of many investors.
Being said that, with a longer-term perspective, ASO presents many characteristics that invites to be optimistic with its future and to think that, after this near term macro headwinds have vanished, the Company could emerge reinforced and underpin its leadership within the sector. Let’s deep dive a little bit more into the Company.
What makes ASO interesting?
Huge opportunity to grow
ASO operates currently just 260 stores in 16 Southern states of the United States. This means basically to have presence in one third of the United States (and with few stores in many of the states that they are in):
In 2019 the Company decided to temporarily stop its stores openings and now, on April 2022, they have resumed the opening process. ASO expects to open at least 8 stores in 2022 and accelerate the pace in the following years with the goal of opening 80 to 100 stores over the next five years (but with over 850 new location opportunities in mind).
The idea is to first fill out existing and adjacent markets, in order to build scale and improve efficiency and, second, open new markets (e.g. Virginia and West Virginia latter in 2022). Indeed, with regard to the scale, ASO has mentioned that they “could add up to a 100 stores without having to expand (their) distribution networks”, specifically if they stay in the Southern part of the United States.
In order to form a better idea about the potential expansion, we can have a look to one of its main competitors, Dicks Sporting Good (DKS), which is operating almost across all the states:
Specifically, DKS operates 858 stores (729 DICK’S Sporting Goods stores and 129 other specialty concept stores) in 47 states, which is more in line with the footprint opportunity that ASO has in mind and can give us some idea about the potential of the Company to keep growing.
Strong balance sheet
During the last years the Company has carried out an impressive process to strengthen its balance sheet, trying to reduce as much as possible its debt levels:
This has helped the company to reinforce its relationship with all its stakeholders, to refinance and extend its remaining debt; and to drastically reduce it interest expenses:
Improvement of operational efficiencies
In order to increase its efficiency and expand its margins, ASO has implemented several strategic measures:
Merchandise offering improvement by strengthening assortment quality and selection, and exiting/reducing categories that were low profit or did not fit, such as toys, electronics and luggage.
Implementation of pricing and clearance programs, allowing ASO to work during the last years with lower markdown rates and clearance volumes, and so helping to increase its gross margin.
Implementation of a more targeted-oriented marketing and communications, helping also to improve markdown cadence and gross margins.
In stores, they enhanced merchandise flowing and presentation, in order to avoid overstocking and to make the shopping experience more exciting.
Upgraded planning and allocation systems to improve in-stocks and inventory turns and improved assortments with more localized products to target markets and stores with the right merchandise.
Implementation of labor management tools to reduce unproductive activities (e.g. new labor scheduling system, pay-for-performance in the DCs), helping to reduce overtime spend and labor costs.
All these measures and improvements have helped the Compnay to expand its margins and, what is more relevant, are expected to be sticky and to help margins remain above pre-pandemic levels.
Building a meaningful omnichannel business
ASO has been developing during the last years its omnichannel platform and steadily improving its ecommerce proposition: rolling out buy-on-line-pick-up-in-store (BOPIS) and curbside, streamlining shipping and logistics, optimizing its website… All these initiatives have allowed the Company to build a profitable and growing omnichannel business, reach customers outside its store footprint and steadily increase its penetration rate:
However, as it can be observed, its current penetration rate is running just under 10%, below the share of e-commerce in overall retail sales which is estimated to be around 15% or of other companies within the sector, like DKS, with 21%.
In that sense, there is a clear opportunity for the Company to keep expanding its e-commerce business. Indeed, though they do not provide specific targets, they have commented that they “expect omnichannel to continue to grow faster than the stores over time” and that penetration rate “probably will be in the high teens 20% range”.
The geographical expansion, commented at the beginning of this paragraph, is expected to be one of the key drivers of the omnichannel expansion, as this digital expansion will be focused on both the BOPIS program and the use of stores as fulfillment hubs (nowadays BOPIS represents more than 50% of ASO’s total e-commerce sales, more than 95% of total sales involve the stores and 75% is directly fulfilled in stores). This symbiotic relationship between digital and physical will be key for the development of the omnichannel business.
Diversified product assortment and resilient business model
ASO is a company that manages a really diversified product assortment, offering from sporting goods and apparel to outdoor recreation, from hard goods to consumables items, and good/better/best products. This capacity to reach a broad customers base and to serve as convenient one-stop shop reinforces its business model, reducing seasonality and establishing a kind of counterbalanced product assortment (where softening in a particular category may be offset by the remainder categories).
Besides there are other characteristics that confer its business model with an outstanding strength and resilience:
This is a company with a strong focus on value. They position themselves as “the value player in (their) space” where their “everyday value price points help active young families stretch their dollars”. This confers the Company with a resilient business model that could help to better overcome this uncertain macroeconomic environment. Indeed, in that sense, the Company, in its Q3 2021 conference call, mentioned that “the best performing years that the company had prior to the past few were in 2008, 2009 to 2010 when the consumer was strained”.
ASO is not excessively concentrated in any of its vendors (its largest vendor represented approximately 11% of its total inventory purchases in 2021) and works with approximately 1200 vendors. In that sense it is less exposed than other retailers to potential disruptions coming from those vendors (e.g. increasing focus on DTC strategies by many national brands).
ASO leans more on its private brands than other retailers and indeed around 20% of its sales come from them (vs for instance DKS where this percentage is 14%). As the Company comments, private brands “play a key role in (their) business by reinforcing (their) value message, filling in gaps that are not occupied by national brands, while also being margin accretive” and they “don't see the percentage of private brand going down” and that “maybe over time, it settles in longer term and somewhere in that 75-25 ratio”.
This resilience provides the Company with a rather comfortable position under this inflationary and macroeconomic environment. Its position as the value leader in their space might help to drive traffic to its stores and to better overcome this challenging situation.
Strong relationships with its partners
I discussed in a previous article the issue of the uncertain current situation of (some) sporting-goods retailers and of them being out of favor and considered under the sword of Damocles of being disintermediated by the big brands (like Nike, Adidas or Under Armour). Fortunately ASO seems to be outside of this group of “undifferentiated” partners that are expected to be affected by the disintermediation process and, conversely, to be one of those strategic partners on whom national brands rely on.
Indeed this consolidation process, together with the improvement of ASO’s financial strength, seems to be helping the Company to gradually get better product availability and inventory allocation from its partners, reach new brands and get even improved terms and conditions in its relationships.
Additionally, vendors’ new distribution strategies are expected to help those strategic companies like ASO to funnel more customers into their stores, gain market share and increase brand relevance. It is also expected that all these shifts help to rationalize the promotional environment, by lowering promotional pressures and leveling off above pre-pandemic levels.
Despite being vendors’ focus mainly on the digital space and DTC strategies, the volume still canalized through its retail partners and the customer base that can be reached through them are huge. This makes the vendors relationship with these key retail partners expected not to be cut off in the short-to-medium term and even to be strengthened going forward.
Profitable business model
There is no doubt that the pandemic period has provided some tailwinds to the Company that helped its sales and margins to expand, especially the leverage produced by sales increases and the more favorable environment for merchandise margins and regular-price selling:
However, many of the measures and improvements commented in the previous paragraphs have also played a relevant role and are expected to be stickier and to help sales and margins remain above pre-pandemic levels.
ASO recently commented, talking about its gross margins, that they think the days of going back below 32% or 32.5% are behind them and that they expect to be in the long-term somewhere between that 32.5% and the current 35% levels. The Company does not discard some margin pressure due to a more promotional environment but there are other levers that will push in the opposite direction: improved product mix, as lower-margin hardlines come back to a more normalize percentage of the mix; the impact of operational efficiencies, as for instance better inventory allocation or markdown optimization strategies; supply chain improvements and (expected) lower freight costs under a more normalized environment… There might require some time, but in the medium-to-long term all of these levers could help to keep gross margin above pre-pandemic levels.
Indeed in the last conference call they mentioned that “the bulk of the gross margin builders to 2019 revolve around the merchandise planning and allocation work that Steve and his team have taken on” and that they “think that that is 475 to 500 basis points of sticky, gross margin benefit”.
With all these measures, together with the leverage provided by the expansion of the store footprint and the ecommerce business, the Company expects “to hit that double-digit EBIT margins on a long-term basis and sustain that”.
New management
After some years of lackluster results, ASO started an important renovation of its management in 2017, appointing new CEO and CFO and bringing together an experienced group of professionals:
Especially relevant was the appointment of the new CEO, Ken Hicks, which is a highly-regarded retail veteran who was president and CEO of Foot Locker from 2009 to 2014. During his tenure, he was able to almost 4x Foot Locker’s value:
Of course this stock price evolution provides no hints at all about the potential evolution of ASO, but at least gives an idea about the capacity of the new CEO and what he can accomplish.
Besides, according to the last Proxy Statement, the management possesses a relevant (in terms of dollars) ownership of the Company common stock (including stock options and PSUs and RSUs), which is always remarkable in terms of alignment of executive officers and stockholders:
Executives like the CEO, the CIO and the CFO have a participation valued at current stock prices more than $50m, $16.2m and $12.1m, respectively (including $778 thousand recently acquired by Ken Hicks in January 2022 at an average price of $38.91).
Growing industry
The outdoor recreation industry has enjoyed many tailwinds arising out of the COVID pandemic. However this is an industry that had been seeing increases in participation across several categories during the pre-pandemic years and, even though some normalization might be expected, it will probably keep thriving in the future and do it at heightened levels (compared with the pre-pandemic situation). But let´s deep dive into this issue in the following paragraph.
Sporting goods and outdoors industry
There is no doubt that sporting goods and outdoor recreation is a category that flourished during the pandemic. Thanks to different factors, this category clearly took off during 2020/2021 and, in that sense, it would be expected some sort of reversion during the next periods.
However, there are two points that invite to be optimistic with this category. On the one hand, the positive performance of this category was well underway before the pandemic began and the factors that were behind this trend remain largely unchanged (or might be even reinforced during the pandemic). On the other hand, the pandemic might have created a large-scale and long-lasting positive shift in the consumer behavior.
How was this category performing before the pandemic?
Before the arrival of COVID-19, there were numerous secular trends under development that were making this category to flourish: renewed focus on health and wellness; need to reconnect with the outdoors in response to the fatigue of day-to-day lives; behavioral shifts to more healthy lifestyles, such as the growing interest in healthy food or in walking or cycling to work; booming of fitness centers, gyms and health clubs… Let´s have a look to some charts in order to have a more graphic idea of all these tendencies:
Although outdoor participation rate has remained rather flat (and slightly growing since 2013), the number of Americans participating in outdoor activities has been steadily increasing since 2008, to reach more than 160 million people in 2020. This means that more than 50% of the population is making some outdoor activity. Besides, most outdoor sports and activities show increasing interest:
Sports like running, jogging, bicycling or hiking have been on the rise during the last years, as is the case of activities like kayaking or backpacking. There are others that have had more stable paths (e.g. camping, hunting or wildlife views) but in any case there are no activities showing relevant declines.
Similar conclusions were reached in a survey carried out in 2020 by the Physical Activity Council where they tracked sports, fitness and recreation participation in the US:
Additionally, this survey provided a relevant insight about next generations, as it seems youth participation is also in good health.
In order to contextualize the relevance of all these activities, let’s have a look at the following chart:
It can be observed that many outdoor activities are much more relevant in terms of participation than other more “glamorous” activities like golf, tennis or baseball, and that some of them involve several millions of people.
From a more general perspective, we can get a similar feeling if we look at sporting equipment consumption:
It is pretty clear that 2020 has been an outlier, but we can observe that sporting equipment consumption represents an increasingly important part of consumers’ expenditures.
Although rather in line with the GDP growth, the sporting goods industry has been steadily growing since its last contraction in 2009 (-4.3%) and was even able to avoid negative growth in 2020 (+0.3%).
Despite showing some sort of stability during the last years, the average percentage of the U.S. population participating in sports, exercise and recreational activities has been increasing during the last three decades.
The number of fitness centers and health clubs memberships within the United States has experienced an almost continual increase between 2000 and 2019.
All in all, these charts and statistics help to better understand this positive trend that the sporting goods and outdoor recreation industry had been enjoying well before the pandemic started, and that many of the reasons behind this trend are still in place. However, this industry, as almost every other industry, has not remained at all unaffected during the pandemic. Let’s have a look to this more recent period.
Could the pandemic have created a large-scale and long-lasting consumer behavior change?
There is no doubt that the COVID has stimulated many sporting and outdoors activities and, despite being expected some reversion as people return to pre-pandemic routines, there are trends that seems to be here to stay.
Many industry analysts are observing that consumers who discovered the outdoors when the pandemic began are sticking around. In a survey carried out by Outdoor Industry Association together with NAXION in March 2021 they asked the new participants how likely they will continue to engage in the outdoor activities after the pandemic:
As it can be observed, many of the respondents had the intention to continue their outdoor participation and across different activities. Indeed, it seems that the pandemic, far from stopping pre-pandemic trends, could have reinforced the interest in health, fitness and outdoor activities.
This heightened interest is having an impact in the sporting goods and outdoors sector. In a recent article of The NPD Group they state that “with 44% of U.S. consumers placing more focus on their overall health and wellness today than they did before the pandemic, apparel, footwear, and sports equipment categories rooted in comfort and outdoor lifestyles are growing in sales”.
These optimistic feelings about the future are also shared by many players within the industry. Let’s have a look to some comments provided in the last conference calls:
DKS comments in its Q1 2022 conference call that “these top line results reinforce (their) strong conviction that the shift in consumer behavior over the past two years is indeed structural” and that “consumers have made lasting lifestyle changes, with an increased focus on health and fitness and greater participation in sports and outdoor activities”. They reinforce this idea by stating that almost “every single category in (their) business, virtually everyone except for hunt, has rebaselined meaningfully higher than pre-pandemic volume”.
AOUT, in its Q3 2022 conference call, also talks about “longer term trends, such as increased participation in the outdoors, as well as a focus on active and healthy living” and comments that they are “seeing continued growth in outdoor lifestyle”. They are “seeing continued strength across the board” on the outdoor lifestyle side and “tremendous strength right now” across many of its main outdoor categories (hunting, fishing, camping, rugged outdoor).
COLM declares in its Q1 2022 conference call that “the growth in the outdoor business during the pandemic was very significant” and that they “expect that that's going to continue to grow, people will spend more time outdoors, as well as the casualization of the workplace”.
VSTO also express its optimism about the future in its Q3 2022 conference call: “Activity and participation rates across outdoor recreation continue to rise, whether it be golfing, camping, hiking, biking, hunting or recreational shooting. Two years into the pandemic, people are finding enjoyment in their newly acquired and rediscovered outdoor passions. Whatever they're chosen activity, this outdoor will continue to be there with brands they trust to deliver innovative quality products that enhance their outdoor experiences”.
VFC also comments these secular trends in its Q3 2022 conference call: “Globally, we continue to see robust demand for outdoor and active categories. Outdoor participation continues to grow, supported by secular trends towards more active, healthy lifestyles”. Besides in the Q2 2022 conference call they mentioned that “the macro trends around outdoor and active lifestyles, health and wellness, casualization, and sustainability have only strengthened over the past 20 months”.
JOUT comments on the stickiness of this increased interest in its Q2 2022 conference call: “The great news is that people continue to want to recreate outdoors and we're seeing continued robust demand for our products across the businesses”.
NWL also states its optimism in its Q1 2022 conference call: “Our diverse all weather portfolio is well positioned to capitalize on the evolving consumer trends surrounding hybrid work, Homes hub as well as increased focus on well-being, outdoor activities and sustainability”.
CWH makes a clear statement in its Q1 2022 conference call: “From our perspective, the world's passion for the outdoors has never been hotter”.
Finally, even ASO commented in its Q4 2021 conference call that “over the past two years millions of people have purchased home fitness and outdoor equipment such as bikes, pickleball, fishing rods, barbecue grills or they started hiking or camping. We believe that many people made lasting changes to their lifestyle priorities during the pandemic and we'll continue to enjoy these new activities and hobbies they started for many years to come”
All in all there is a widespread feeling that the positive secular trends, that started well before the pandemic began, will keep supporting the industry and that they will probably do it from rebaselined higher levels.
What about the short term?
Generally I don’t care about the short-term performance of a company. Should the company is structurally sound and its business model is expected to keep thriving and growing it is not really important what could happen during the next quarters.
Being said that, we are under an extraordinary macroeconomic situation and I think this time might be useful to highlight some black clouds in the near horizon.
Post-pandemic reversion
There is no doubt that the pandemic period (and the multiple monetary and economic measures taken within it) has clearly distorted the economic landscape. 2020 was a really challenging year where lockdowns hugely impacted demand, specifically in the case of brick-and-mortar companies. However, 2021 was a really exceptional year where stimuli and pent-up demand pushed demand to stratospheric levels.
Now, in 2022, it is expected to witness some sort of normalization process and so many companies are reporting that they are anticipating softening demand and comp difficulties with stimuli lap (at least for the first half of the year, when those effects were more intense in 2021).
Companies like DKS comment that they are feeling some “normalization in certain categories that surged throughout the pandemic” and specifically they talk about fitness and outdoor equipment. Stuff like bikes, paddles or golf equipment are returning to more normalized levels as hard goods are “consumed” in longer periods of time. Even ASO commented in its last conference call that “categories such as fitness, fishing and bikes saw an outsized benefit from the shutdown associated with the COVID pandemic” and that “these businesses are not sustaining the same level of demand as they did in 2020 and 2021” (although “even at the reduced volume levels, they're still in aggregate up over 20% versus 2019”). However they have the feeling that there are categories that are reverting back to where they were historically (e.g. pool, grills) but there are others that are expected to revert back a little bit but rebaseline well above pre-pandemic levels (e.g. bikes, fitness or fishing). And there are even some categories that are strong and selling better than last year, like camping and hunting.
Besides many companies expect some normalization of the promotional landscape. Again the pandemic has been a period of historically low markdowns and, even though most of the companies do not expect to come back to pre-pandemic scenarios, they “assume that markdowns will begin to normalize through the year”. Adding fuel to the fire, during the last quarters many companies, due to supply chain uncertainties, have been accumulating inventory and this could create some problems at sectorial level. Indeed there are some companies like BGFV that make mentions of “higher carryover”. In this regard, ASO, in its Q1 2022 conference call, makes a really interesting statement on this issue:
“The other thing, we've talked about a lot is inventory as a leading indicator and fortunate element of retail is that the problems of others could become your problems, and we need to be mindful of the overall inventory build that we've seen in the sector and retail in general. And I think in this environment, it's wise to be cautious, which is why we wanted to update our guidance to get ahead of the potential that the back half of the year could be more promotional as planned”
They are basically saying that, regardless of carrying out a sound and conservative inventory management, some companies (like ASO) could suffer a promotional environment triggered by other companies that accumulated excessive inventory.
Macro-inflationary impact
In spite of the impact that the reversion commented in the previous point could have in terms of demand, most of the companies report that they are still seeing continued strong demand for recreational and outdoor products. Companies like DKS and SPWH mentioned in their last calls that apparel and footwear are categories that are performing well, together with ammunition and hunting.
Being said that, they are also starting to report that the relevant inflationary pressures might be influencing consumer behavior. Companies like SPWH comment “that a high rate of inflation may be influencing consumer shopping habits” and that they “started seeing some initial slowdown in the consumer behavior”. They specifically comment some softening demand in hardlines and higher consideration products like grills or kayaks. DKS also comments “that the consumer is really in a very challenged state right now”. HIBB comments that their customers “believe that rising inflation will have a general impact on their discretionary retail spending”, though it also states some offsetting factors:
“We think that the factors that overcome that are the fact that their wages have gone up and that employment is very strong”.
“But things that are going the other way for the consumer are that wages have increased along with that inflation. The employment situation has dramatically improved with regards to a specific situation for us, the competitive set has improved, right? So there is less product available”.
Apart from this impact in terms of consumption, this macro-inflationary environment is putting a lot of pressure in terms of costs. Product, transportation and labor costs are all increasing and there are no still clear signs of normalization in 2022. Inbound and outbound freight costs might be a headwind to gross margins and wage inflation might pressure SG&A expenses (and so EBIT margins).
Supply chain disruptions
Although there are some signs of normalization, supply chain disruptions are still a relevant issue. Almost every company makes a comment in its last conference call: DKS talk about “navigating a dynamic global supply chain environment through the rest of the year”; JOUT and BGFV comment that they are “continuing to face disruptions in (their) supply chain”; HIBB mentions supply chain issues affecting inventory levels; FL comments that “supply chain volatility continues” and that “supply chain cost to be a drag on (their) margins”. Even ASO comments, talking about 2022 guidance, that they “expect elevated supply chain costs”. These higher costs, together with the deleverage of fixed costs due to the expected softening on demand, might add additional pressure on gross margins.
All these issues (post-pandemic reversion, macro-inflationary impatct and supply chaing disruptions) represent clear obstacles in the short term and could help keep this sector out of favor for a while. However, in general terms all of them seem to be circumstantial issues and are not expected to suppose structural challenges for the sector in the medium-to-long run.
Peers comparison and valuation
There are many companies to compare with within the sporting goods and outdoors recreation industry, but probably, in terms of business model, these following companies might be considered ASO’s main peers (among the public ones):
Big 5 Sporting Goods Corporation (BGFV)
Dick's Sporting Goods, Inc. (DKS)
Hibbett Sports (HIBB)
Sportsman's Warehouse Holdings, Inc. (SPWH)
With different sizes and geographic expansion, all of them are sporting goods retailers offering a broad selection of sporting equipment, athletic footwear and apparel, with a mix of national and private brands.
Let’s have a look at some valuation multiples for these companies in order to have a broader perspective:
As it can be observed, all the companies within the sector present rather similar valuations. The market gives a similar low multiple to all the companies within the sector, considering that all of them might be in analogous situations. Indeed, as explained at the beginning of this article, this is a sector that is rather out of favor and within an uncertain situation because of the potential risk of being disintermediated by the big brands. This general circumstance seems to be the reason for the market not to discriminate, regardless of being these companies in very different situations. Indeed it is rather telling that the market gives a similar valuation to BGFV, a company that has been already “disintermediated” by Nike, than to the other companies that are still considered strategic partners.
Besides, all these companies present rather different store-level performance (data as of end 2021):
As stated in the chart, ASO is outperforming its peers in terms of sales and productivity of existing stores, and the company expects each new store “to have an average return on invested capital of at least 20%” and “to be EBITDA accretive creative after the first year of being open” (Q1 2022).
All in all, ASO is a company that clearly stands out over its peers and, additionally, it is in a great position to keep growing across the rest of the country. Doing a back-of-the-envelope valuation, using the Company’s 2022 guidance of $765m income pre-tax forecast and assuming a similar level of interests than the last 12 months (around $45m), we would have a company producing approximately $810m of EBIT by the end of 2022 and trading at 4x EV/EBIT. With a strong balance sheet and capacity to overcome potential short-term headwinds, this doesn’t sound like a stretched valuation.
Nice write up. I'm long ASO. I came to a similar conclusion as you ASO being the best way to express the undervaluation of this sector.
I have been thinking about if ASO compares favorably because of it's state as an institution in Texas. As they expand outside of their core area I'll be interested to see if their stores still perform better than peers.
One piece of constructive feedback. You use the word "indeed" alot in your writing. I've found cutting out these filer words in my own writing has helped me.