The Long and Short
Price and curve play to Dick’s Sporting Goods
Meredith Contente | September 16, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Dick’s Sporting Goods remains the widest trading credit in the ‘BBB’ retail space excluding department stores, despite having margin and credit profiles similar to or better than peers. Recent quarterly results beat consensus estimates, prompting management to raise full year-guidance. Furthermore, net sales and EBIT levels are considerably higher than pre-pandemic levels. Bonds issued in January of this year are now trading at a deep discount and have the steepest 10s/30s curve in the peer group, providing for an attractive entry point.
Exhibit 1. BBB Retail Spread Comparison
Credit/Margin Profile Stronger Most Peers
DKS stacks up very favorably to BBB retail peers when looking at both its credit metrics and margin profile (Exhibit 2). DKS has historically maintained conservative financial policies which is evident by its very low leverage for the current credit ratings. While inflationary pressures have crimped margins across the retail space and bloated inventory levels have forced heavy promotional activity, DKS’ EBITDA margin is expected to remain the mid-teens area. Lease adjusted net leverage of 1.2x is at least a turn below retail peers. Excluding leases, total leverage remains below a turn (0.9x) and DKS is the only peer in a net cash position.
Exhibit 2. BBB Retail Margin and Credit Profile Comparison
From a ratings perspective, both Moody’s and S&P maintain a 2.5x leverage threshold for the current ratings. Both agencies estimate that adjusted leverage continues to hover around the 1.0x area, providing sizeable headroom under the existing ratings, should EBITDA fall short of consensus estimates. Leverage is likely to remain around the 1.0x are for the foreseeable future, unless there is significant change in financial policy and/or a management shake-up.
Full Year Guidance Raised
Given the better-than-expected second quarter results and improved inventory position ahead of the ever-important back-to-school selling season, management raised full year guidance. DKS is now forecasting that comparable store sales will now decline in the 2%-6% range versus previous guidance of down 2%-8%. Additionally, the company now expects adjusted EPS to be in the $10.00-$12.00 range, up from previous guidance of $9.15-$11.70. The increased EPS guidance is not dependent upon any further share repurchases, but management noted that they will continue to be opportunistic with buybacks as the year progresses. However, DKS’ stock has made a strong move higher from its 52-week low posted on 5/24/22 and is now in positive territory from a year-to-date change perspective (Exhibit 3). That said, management may find better returns on cash other than share repurchases.
Exhibit 3. DKS Equity Performance (9/15/21-9/15/22)
When asked on the earnings call why management chose to raise guidance given the uncertainty in the retail environment, they noted that sequential monthly comps improved during the most recent quarter. DKS experienced a higher proportion of out-of-stock items that negatively impacted first quarter results. However, inventory levels have improved, and sought-after items were in stock heading into the back-to-school season. Additionally, management noted that product mix has meaningfully transitioned toward higher-margin and narrowly distributed products, making a larger portion of inventory less susceptible to pricing pressures and promotional activity. DKS is also carrying more private label inventory which boasts higher margins, roughly 600-to-800 bp more margin than branded items. These factors should provide for DKS to maintain a larger net sales and operating margin base than witnessed pre-pandemic.
Convertible Exchange Underscores Conservative Policies
In June, DKS entered into an agreement to exchange $100 million of its convertible senior notes due in 2025 for cash. Concomitantly, DKS unwound the corresponding portion of the convertible note hedge and warrants for 1.7 million shares of the company’s common stock. Given DKS’ strong cash position which stood at $1.9 billion at the end of the fiscal second quarter, the rating agencies tend to view leverage from a net perspective. That said, the exchange will have a minimal impact to its current leverage ratio. However, the use of both cash and equity for the exchange was viewed positively by agencies and S&P noted that it highlights management’s conservative financial policies.