In January 2022 I wrote an article about Hibbett Sports (HIBB) detailing why, although I did not consider this company as a “high quality” company, I did regard it as a solid one. This, combined with what I thought it was a low stock price, made me consider the opportunity as a pure value play. Since then the stock price has had a volatile behavior and now is trading at 2-years low (orange line in the chart below):
Looking at this chart we can observe that there are two clear winners (ASO & DKS) and three losers (HIBB, BGFV and SPWH) within the sector. The goal of this article is to understand the reasons behind this underperformance and, more importantly, if those reasons are structural or temporary. In other words, if the conclusion is that those reasons are temporary, could we consider that HIBB represents an interesting opportunity at the current prices? Let’s see.
Management’s Mistakes
When the stock price of one of your positions moves in the “wrong” direction it’s rather common to think that markets are irrational and that they are completely mistaken. However it is even much more common to finally realize that there were good reasons behind these movements and the market was actually ahead of you. Besides, short-term market movements tend to be much more influenced by short-term circumstances than by long-term reasons.
Taking all this into account, I think the market is rightly penalizing HIBB. The Company has recently made some mistakes that may justify the current negative valuation:
Inventory overhang
During the last years inventory planning has been extremely difficult. In 2020-2021 supply chain disruptions and artificially-stimulated demand forced companies to struggle to get inventory and deal with unpredictable lead times. Since 2022 the tendency has reversed and now the problem is to adapt to a new context characterized by the supply chain normalization and a deteriorating consumer demand. The problem with HIBB (as with many other retailers) is that it has not been capable of better predicting this tendency reversion and has been caught off guard:
Although the Company claims that these inventory levels are more a consequence of price inflation and product mix (instead of materially higher inventory units), the reality is that HIBB currently holds excessive inventory. The Company is trying to overcome this indigestion but the problem is that solving this issue will require some pain in the form of promotional activity and margins compression.
Debt Levels
In close relation with the previous point, higher inventory levels has led to higher debts levels and those levels are expected to remain high until HIBB is able to significantly reduce its inventory. Let’s have a look to the last quarters:
Being actually not worrying levels (i.e. 0.5x leverage ratio), HIBB has increased its debt levels in the worst moment, with inventory turns rapidly declining and interest rates increasing. This situation will probably not affect HIBB’s survival but it will drag its profitability in the short-term.
Capital Allocation Errors
This is again a point related with the previous paragraphs. By the end of Q1 FY22 (May 2021) HIBB had $270M cash on hand and no debt but in the following two quarters the Company spent ~$200M in stock repurchases at peak levels (avg price ~$83):
It is true that sometimes is not fair to judge with the benefit of hindsight, but clearly HIBB was unable to understand the macroeconomic context at all and left the Company with less than $30M in cash. Indeed there are many companies that made similar mistakes during the last years (there is an interesting article of Andrew Walker that deeper discusses this issue), but the fact is that HIBB is one of them and this error has made the Company to be forced to increase its debt levels.
All these mistakes have put the Company in a challenging situation in the short term. However this is exactly the definition of a value opportunity: a company with short term problems (that are probably already embedded in the stock price), but with capacity to overcome them and keep thriving in the future. So the point in these situations is to understand if the long-run thesis has changed because these issues can be considered structural, or contrarily this is a temporary situation and the thesis is still valid.
What About the Long-Term Thesis?
In my opinion the long term thesis remains intact. As commented in the previous article, the “athletic footwear and apparel distribution industry is constantly under the sword of Damocles of being disintermediated by the big brands (like Nike, Adidas or Under Armour)”. However “Hibbett has a differentiated business model that is highly complementary to the big brands and it’s not expected to be disintermediated by them in the near future. Indeed it is expected, as the reorganization of the sector goes forward, the company to reinforce its position and gain additional business and market share”. These statements haven’t changed at all and indeed HIBB seems to be reinforcing its ties with its main partner, Nike:
Despite Nike’s intention to keep reducing its sales to wholesale customers and being HIBB clearly not one of the largest Nike’s wholesale partners, its importance to Nike has been steadily increasing. As also explained in the previous article, “Hibbett provides a complementary geographical footprint to Nike and access to a huge network of stores focused on underserved communities. This lack of overlapping between Nike’s and Hibbett’s footprint, and the access to and contact with a different customer base that the latter gives the former, makes Hibbett a valuable partner for Nike (and the other big brands) and invites to think that it won’t be cut off in the near future”.
In close relation to this point, HIBB keeps expanding its position in underserved markets and successfully executing its unit store growth strategy, and indeed has reaffirmed its “expectation to open between 40 and 50 units” in FY24:
Besides HIBB keeps increasing its revenues and is being able to maintain its productivity well above pre-pandemic levels:
Despite the macroeconomic pressure on its customer base and the abovementioned process of inventory rationalization, HIBB is being able to operate at higher levels than pre-pandemic and it is partially offsetting gross margin deterioration with improvements in terms of operational efficiency. The Company has recently adjusted its guidance down, signaling additional margin pressures and some deleverage for FY24, but even under this challenging environment it is expected to reach operating margins in the range of 7.5%-7.8% (well above the 3% of FY20).
Finally, its financial position has recently deteriorated a little bit, as explained above in the paragraph devoted to debt levels, but this is something that is expected to be fixed in the near term once inventory come back to more normalized levels.
All in all, the investment thesis remains valid for the long-term. There is no doubt that it will require some time for the Company to digest its pandemic excesses and for the management to recover its credibility, and this might mean additional downward pressure for the stock, but I do think this is still a solid company with a differentiated business model and executing for the long run.