Despite 1Q23 disappointing results, ASO is doing everything right to thrive in the long run: ramping up its store growth, deploying a meaningful capital allocation, working on operational efficiencies, increasing e-commerce and private brands penetration…
The Company is outperforming its peers and presents structural characteristics that confer with a resilient business model in case of a downturn.
There are some negative aspects that deserve to be highlighted (CEO transition, potential margins compression and consumer discretionary nature) but not enough to derail ASO’s outperformance.
Within my base case scenario the upside might be 140%+ within a five years horizon, but if ASO were able to achieve the ambitious goals stated in its last Investors Day, they could multiply by many times.
Revisiting Academy Sports and Outdoors
A year ago I wrote an article about Academy Sports and Outdoors (ASO) where I detailed why I liked this company so much. At that time the company was trading at $38 and it almost double in less than one year, peaking on April 2023 at $68. Now the stock has receded almost 30% (to ~$49) and it seems an interesting point to think about the current situation of the company.
What Is The Current Situation Of The Company?
ASO reported first quarter 2023 results some days ago and they were certainly a little bit disappointing. These results were below expectations with a gradually-softening business during the year, lower comparable sales than expected and some pressure on margins. The Company (slightly) reduced its guidance and there is no doubt that 2023 will be a challenging year.
However, I would like to look at the Company with a broader time perspective because the relevant point is not what is expected ASO to achieve in the next quarter/s but where this company could be in three to five years. And in that sense the Company is doing almost everything right:
Ramping up store growth
In the previous article I highlighted ASO’s huge opportunity to grow: “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 company is effectively accelerating the pace and it finally opened 9 stores in 2022 (including two new markets such as Virginia and West Virginia), and now targets 13 to 15 new openings in 2023 and 120 to 140 over the next five years (by 2027). The room to grow is still huge and now the Company seems ready to take advantage.
Let’s take a look at the following charts:
As it can be observed currently ASO’s stores footprint (right side of the chart) comprise basically the South Central and South Atlantic regions, which means less than 40% of the outdoor recreation participants (left side of the chart). There is still a lot of room to fill out existing markets and enter new markets, and now ASO has the intention to do it.
Meaningful capital allocation
In my opinion a meaningful capital allocation is one that first allocates capital to the business and secondly distributes excess cash to company’s stakeholders, starting for the debtholders (until target leverage ratio is achieved) and then rewarding shareholders (with special predilection for stock buybacks).
As commented in the previous point, during 2022 ASO reinitiated its growth plan with investments in new stores. Additionally the Company has kept reducing its debt levels (-$100M, leverage ratio 0.25x) and repurchased $489M in stocks (~14% of its shares, avg. price $41/share). And all these activities have been self-funded with cash from operations.
Working on operational efficiencies
As exposed in the previous article, ASO has implemented several strategic measures during the last years in order to perform in a much more efficient way and so to be able to expand its margins. Most of these measures were focused on improving buying, planning and allocation strategies. Now that some margin headwinds are starting to unfold (as we will discuss in the next paragraph) those strategic measures are helping to offset the negative pressure and to keep margins (structurally) higher.
Additionally during the last Investors Day the Company presented many new initiatives to keep improving its supply chain costs and profitability in the future. As I will discuss later, there will be some negative effects that will put some pressure on margins, but those initiatives will help to keep them well above pre-pandemic levels.
Most profitable sporting retailer
ASO keeps outperforming its peers in terms of sales and productivity:
Despite a reduction of sales and EBIT per square foot in 2022, ASO is still leading its peers’ group and indeed it has been able to increase the gap with its closest rival (DKS) thanks to its capacity to keep the margins at heightened levels.
Increasing e-commerce and private brands penetration
Although it is still behind some of its peers and the overall retail, ASO keeps increasing its e-commerce penetration rate and it is right now even above pandemic levels.
Additionally the Company is also working to increase is private brands penetration (with higher gross margins associated) and it aims to move from the current 21% to 25% in 2027.
Attractiveness in downturns
As commented in the previous article, ASO is a company that manages a really diversified product assortment and this capacity to reach a broad customer 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).
Additionally this is a company with a strong focus on value and this confers with a resilient business model that could help to better overcome uncertain macroeconomic environments. As macroeconomic concerns and consumers’ pressure have both increased, these diversified assortment and value proposition make ASO to be in a relatively advantageous situation compared to other retailers. Besides, as ASO’s management claims, this sector is not “as discretionary as other parts of the discretionary business” and the sporting-goods industry is an “industry (that) has proven to be more resilient in downturns, bouncing back faster than others”.
Negative Aspects
CEO transition
One of the main positive points that I highlighted in the previous article was its management and specifically its CEO, Ken Hicks, who was transforming and turning around the Company. However in April 2023 Ken Hicks decided to retire from the front line and transition to Executive Chairman, and the Board appointed Steve Lawrence (former Chief Merchandising Officer) as new CEO. This transition seems to be more related with Ken Hicks age (70) and not with any discrepancy between the executive and the Company, but anyway it is a relevant loss in terms of leadership.
However it is encouraging that all the changes carried out in this reorganization (the CFO and the VP of Retail Operations have also assumed additional responsibilities) have been filled internally and it is expected to be full alignment and a continuation with the current strategic plan.
Margins compression
The pandemic period created some dynamics that made possible for many retailers to expand its margins. Basically supply chain disruptions limited the access to many goods and this, combined with an artificially-stimulated demand, originated a supply-demand imbalance and the perfect breeding ground for margins expansion. Additionally, increased sales levels led in many cases to operational leverage and so higher operational margins. All these stuff have allowed companies like ASO to reach margins well above pre-pandemic levels.
During its last Investors Day ASO reassured that they feel they will be able to keep those new margin levels, with gross margin “expected to be 34%-34.5% each year of the long range plan” and EBIT margin reaching 13.5% by 2027 (i.e. +920bps above 2019 levels). In my opinion those targets are rather ambitious and will not be easy to achieve. ASO merchandise margins are ~500bps above pre-pandemic levels and the Company claims that “the vast majority of what (they) picked up over the last couple of years is going to stick to (their) roads” as it is the result of merchandising changes and improvements in inventory management, systems upgrades and greater localization. However, if we look at the following charts that depict gross margins evolution in ASO and its peers (the one on the left does not show ASO and SPWH because they were not public at that time), we can clearly observe two relevant aspects: gross margins have been rather stable pre-pandemic during a long period of time and the pandemic supposed a big jump for all of them (and so this looks like an anomaly):
This does not mean necessarily that ASO will not be able to keep its current margin levels, but that would not be my base case as there are many specific circumstances that affected the pandemic period that are disappearing and so the positive effect on margins will also disappear. The return to a more normalized environment and competitive pressures will probably have an impact on merchandise margins that will be difficult to offset just with internal measures. For instance ASO, as many other retailers, do not think they “are ever going to go back to where (they) were in 2019 and prior from a promotional intensity perspective” thanks to improvements in their internal processes. However the intensity of the competition and the level of markdowns are variables that are not entirely under the Company’s control (if they want to remain competitive) and this is something that we are observing all across many retailers: as supply chain problems cease, inventory normalizes and demand starts to be under pressure, the promotional environment rapidly reemerges.
In that sense, I consider the previous targets of the Company, which were gross margins in the range of 32%-32.5%, and 10%-11% EBIT margins to be much more realistic. These ranges already take into account internal improvements, but with a more normalized retail environment.
Macroeconomic environment
The current macroeconomic situation remains rather unstable and it is extremely difficult to predict if there would be a hard, soft or no-landing at all. In any case, there is no doubt that in case of a recession the Company will suffer. However this is not relevant with a longer-term perspective. With regard to this issue, the relevant point is to understand if the Company would be able to overcome a potential crisis and how it would emerge from this crisis.
As commented in the previous article, “the Company has carried out an impressive process to strengthen its balance sheet, trying to reduce as much as possible its debt levels”. In that sense its financial position seems strong enough to get through a potential crisis without excessive problems.
Additionally, as I mentioned in previous paragraphs, though ASO is part of the consumer discretionary sector, it possesses some intrinsic characteristics that could help to offset an economic downturn. ASO is the kind of company that would probably gain market share and reemerge stronger in case of an economic crisis, mainly as a result of its strong focus on value and the potential bankruptcy of some of its peers with worse financial conditions.
Valuation and Final Thoughts
As commented in the previous article, there are many companies to compare with within the sporting goods and outdoors recreation industry, but probably, in terms of business model, DKS, HIBB, SPWH and BGFV may be considered ASO’s main peers (among the public ones). 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.
In order to have an idea about the current valuation of ASO and where this valuation might be, let’s have a look at some multiples for these companies (EV calculation includes lease liabilities for reasons of homogeneity):
As it can be observed, these companies have fluctuated around 10x EV/EBIT, which is the median of the sector during the last decade. ASO went public in 2020 so there are few data points and probably distorted by the pandemic period, but its peers have fluctuated around 10x, specially DKS which is probably the most similar one to ASO. Besides, as it was stated above, ASO is the most profitable sporting retailer and with a lot of room to keep growing, and it would be reasonable its multiple to converge (at least) with the sector median. However, in order to better understand what the valuation of this company could be, let’s analyze three different scenarios:
2023 Investors Day scenario:
This scenario follows ASO’s 2027 goals stated during the April 2023 Investors Day. The Company expects to reach $10+ billion revenue in 2027 by both opening 120 to 140 new stores that will generate on average $20M per store (2027 lease liabilities have been adjusted in accordance) and implementing improvements in existing stores that will make them to produce on average $28M-$30M (well above $24M FY22 sales per store). Additionally the Company expects to be able to keep margins rather in line with heightened pandemic levels and reach 13.5% EBIT margin by 2027 and so be generating $1,350M in EBIT in five years. This scenario also includes the FCF generation during the period considered, which the company quantifies in $3,500M with a weird calculation as it starts with the EBIT (not with the EBITDA) and deduct CapEx and Working Capital (so it seems that there might be some sort of double deduction of depreciation/amortization and CapEx):
Anyway, should the Company is able to reach its goals, and assuming a 10x multiple, the upside would be huge and ASO could multiple by 4 in five years.
Base case scenario
This scenario lowers ASO’s 2027 expectations. It still expects to reach 120 to 140 openings with an average of $20M per store (opening path seems rather healthy right now) but it expects existing stores to generate on average $25M, which is the current maturity level (and still well above pre-pandemic levels). In terms of margins, this scenario takes into account the expected margin compression explained in the previous paragraph and so uses a more conservative 10% EBIT margin by 2027 and ~$900M in EBIT in five years. This scenario also includes the FCF generation during the period considered but quantified in $400M per year (which is the FCF ex WC changes and SBC generated in 2019). This scenario is much more conservative but still the upside is enormous (140%+) with the Company multiplying by 2.5x in five years.
Lower case scenario
This scenario reduces even more the expectations and assumes that the Company will not be able to improve 1Q23 LTM EBIT levels (~$750M) and that the current EV/EBIT multiple will remain unchanged (6.9x). This scenario also includes the same FCF generation of $400M per year stated in the base case scenario. The upside in this case will be lover (37%) but still a non-negligible 7% CAGR under a rather restrictive scenario.
All these scenarios do not try to represent detailed explanations about the path that the Company could follow in the next five years. These scenarios intend to be directional representations in order to have a rough idea about what could happen if the Company goes in these three different directions and show that the opportunity is massive in case of ASO getting things well done and the risk is limited in case of more lackluster performance.
In summary, ASO is still a company that clearly stands out over its peers and is in a great position to keep growing across the rest of the country. This Company is part of the consumer discretionary sector and will suffer in case of an economic downturn, but possesses many characteristics that will help them get through a potential crisis without excessive problems and even emerge stronger. In case this recession materializes, the stock price could keep falling, but the current valuation is far from being tight. With a longer term perspective, this is a company with a relevant upside in case of its management keep doing the good job they started in the years before the pandemic and that could multiply by many times in case of being able to achieve the ambitious goals stated in the last Investors Day.
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