ASO - Academy Sports and Outdoors: Growth And Fundamentals

2023-04-18 09:51:15 ET

Summary

• Academy Sports and Outdoors, Inc. is a US-based retailer that sells sporting goods and outdoor recreational products.
• The company is facing economic headwinds with demand slowing.
• The industry ASO operates within should grow healthily, with ASO positioned well to take advantage of this. Outperformance will be driven by new locations.
• ASO's profitability profile is incredibly attractive and industry-leading, with the company continuing to make accretive gains.
• Our valuation suggests the company has a 17-23% upside from here.

Investment consideration

Unlike many stocks, ASO continued its upward trajectory in 2022, allowing the business to gain substantial market cap. This looks to be driven by the momentum of its rapidly improving financial performance but this could now begin to slow. Economic conditions are changing and growth looks to be easing. Our objective is to assess the current and short-term trading conditions, as well as factors impacting the business. Our objective is to assess if the company remains an attractive investment or if it is time for a consolidation period.

Company description

Academy Sports and Outdoors, Inc. ( ASO ) is a US-based retailer that sells sporting goods and outdoor recreational products. The company offers a wide range of products, including camping equipment, firearms, ammunition, team sports equipment, fitness equipment, patio furniture, and pet equipment, among others. It also sells a variety of apparel, including outdoor apparel, athletic apparel, and licensed team apparel.

Academy Sports and Outdoors sells its products under various brand names, including Academy Sports + Outdoors, Magellan Outdoors, BCG, O'rageous, Outdoor Gourmet, and Freely. The company also sells 3rd party brands.

Share price

ASO was privately held up until it was listed several years ago, with KKR purchasing the business in 2011 .

ASO's share price has trended up since the company was listed, gaining over 300%. This has been driven by healthy growth and improved profitability.

Economic conditions

We are currently experiencing an extended period of heightened inflation, driven by supply issues globally following the pandemic. This has contributed to a rapid acceleration in consumers' cost of living, leading to a natural reduction in certain spending. This has continued to occur, with many retailers seeing demand decline. Retail spending is generally discretionary in nature as consumers can defer spending without materially impacting their lives, thus when required, they do. Interest rates have only compounded this effect, with borrowing costs also rising. ASO is not immune to this, experiencing a net sales decrease of 3.4% and a comparable sales decline of 5.1% in Q4-22 .

Looking ahead, our view is that this will continue to pose a threat to retail. As the above graph illustrates, the most recent decline in inflation is the lowest in the last few months, suggesting rates may need to increase further. This will only compound the impact on consumers, with further defensive actions and thus lower demand. With FY23 growth only down 6% compared to FY22, we could see comparable sales fall in the region of 0-5% in FY23, with store growth potentially giving the company either flat revenue growth or a marginal improvement.

Outdoor activities

In recent years, ASO has seen a significant increase in growth relative to its peers, driven by a combination of factors, including an increased interest in outdoor activities. The pandemic has likely contributed to this, reminding consumers of the value of outdoor activities and the enjoyment associated with this. Further, society as a whole has been increasingly focused on becoming healthier and more active, which is a more long-term driver of growth. This poses an interesting quandary as a portion of the growth achieved is likely one-off in nature which cannot be repeated, while there is certainly reason to suggest strong underlying growth is possible. At least in the medium term, this should allow the business to achieve above-average growth, which means at least 3-5%.

Value proposition

We have established that ASO is operating within a strong retail industry but this does not mean it is easy to gain growth, as competition will inevitably be drawn to this. ASO has focused on value-oriented shopping. We would argue that the majority of consumers are looking for high-quality products at a reasonable price, if not willing to pay a premium. This is because outdoor activities demand quality products otherwise the long-term cost to the consumer will be higher due to replacement. ASO has focused on those looking for a reasonable price, competing directly on the compromise between the two. They can do this by offering a large assortment of products, as well as a host of well-respected brands, alongside their private label brands.

E-commerce

With the value and commercial drivers identified, we can move on to how the business looks to reach its customers. E-commerce is an important trend impacting the apparel industry, with many e-retailers gaining market share quickly in the last decade by undercutting the traditional players. Many consumers have quickly relied upon e-retailers, seeing the convenience married with affordable prices as a win-win. ASO has continued to invest in its online presence, offering customers the ability to purchase online and pick up their orders in-store. This is a fantastic compromise as it creates value for consumers that e-retailers cannot offer. ASO has seen its online sales growth increase quickly initially but looks to have stabilized at a moderate level (2022 increased to 10.7%).

This suggests customers are willing to shop in store, placing value on this rather than jumping at the opportunity to shop online. As ASO continues to roll out online-friendly features, online growth should improve.

Store openings

ASO's primary growth driver in the medium term will be the opening of new locations. The company has ambitious growth targets, with 80-100 new stores forecast in the next 5 years.

If ASO's brand value and the industry trajectory continue as it has historically, this will be highly accretive for ASO. The company's locations are far more profitable than its peers, with Management targeting a ROIC of at least 20%.

This is incredibly impressive and should drive the bottom line performance impressively alongside growth.

In FY21 and FY22, the company achieved 17.8% and 19.1% revenue growth respectively. Assuming the delivery of the company's current store opening plans, our view is that ASO can achieve consistent medium-term growth in the region of 5-10%, with our gut feeling being on the higher end of this estimate. Longer term, the company has seemingly carved out a segment of the market for itself, which it should continue to grow within healthily.

Financials

Presented adjacent is ASO's financial performance since it was listed, with our overall view being very positive.

Revenue has grown at a CAGR of 6%, driven primarily by the company's footprint expansion, supported by fundamentally strong growth in same-store sales. As we have identified, the most recent year has declined as a result of softening demand, which we believe will continue in FY23.

Impressively, the company has been able to improve its GPM, with it increasing by 6ppts. in 5 years. Many of the company's retail peers have seen margins slip due to inflationary pressure on costs. Although ASO has felt this impact, they have net benefits through pricing action. In the most recent quarters, the company has seen a slight decline due to shipping costs. Over time, we can see margins creeping up but not materially.

Further, the company has been able to achieve impressive efficiencies, as S&A expenses have not moved relative to revenue. The company's operational investment has continued to be accretive, with this suggesting many stores are yet to reach maturity. This does, however, suggest EBITDA margin is about as high as it can get.

Net of these factors, the company's profitability is highly attractive. The company has achieved an EBITDA margin of 15% and FCF conversion of 5%. Once WC movements normalize, we can see FCF increasing to 5-8%.

Moving onto the balance, we see the only real issue in the financials. Inventory turnover has declined and ASO's CCC has increased. This suggests the company is seeing a slower movement of stock, supporting the decline in demand. This could mean the company has to discount products in FY23, thus tightening margins.

Returning to the good, the company has been aggressively deleveraging, through debt repayments and growth. The company's ND/EBITDA ratio has declined to 1.2x, allowing for debt raising if required.

Overall, we are incredibly impressed with the financials of this company. ASO's financials look great at a glance but digging deeper shows the fundamental quality beyond this.

Outlook

Presented above is analysts' consensus forecast for the coming 5 years. The amounts look in line with the views we have expressed within this paper, with above-average growth and marginal improvements in margins.

Financial peer comparison

Presented above is a cohort of other outdoor-focused retailers.

ASO performs incredibly well against these businesses, producing superior profitability and relatively similar growth. Importantly, it only looks like Dick's ( DKS ) can operate at a similar profitability level, reducing the risk of an industry pricing war in the short term.

Valuation

Presented above is the valuation of these retail businesses, alongside our quantification of what ASO could be worth. Interestingly, the companies are trading at a very similar level, which aligns somewhat with their financial performance.

The various fair value calculations above have been calculated as follows:

• Comp-based valuation - To value ASO based on its peers, we have assigned the business a 10% premium. This is to reflect its impressive profitability and growth potential through new stores.
• Historic average - This is calculated upon the assumption ASO reverts to its average EBITDA multiple.
• Average of peers - This is a conservative view that values the business in line with its peers without a premium.
• Analyst Upside - This is based on the current Wall St. target price.

Finally, we conducted a DCF valuation with the following key assumptions:

• Revenue growth between 5-9% between FY24-FY27, followed by a perpetual growth rate of 2.25%.
• An improvement of FCF conversion to 6-7%, as WC pressures ease following the short-term economic headwinds.
• An exit multiple of 6x and a discount rate of 9%.

Our view is that the upside here could be between 17-23%, factoring in a longer-term view of the business.

Final thoughts

ASO is a fantastically run business that has been continually improving over the last few years. This has been hidden by the revenue growth the company has achieved but a lot of what is impressive about the company is beyond just this. Looking long term, the company is positioned very well in a growing industry and a strong market offering, allowing ASO to continually open new stores. This said the company is facing short-term headwinds, with demand declining Q/Q. This has the potential to bring negative sentiment around the company and potentially negative price action but over the medium term, all we see is the company winning.

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