ASO - Academy Sports and Outdoors: Recent Drop Seems Exaggerated

2023-05-31 03:51:58 ET

Summary

• Academy Sports has dropped nearly 30% in the past few weeks.
• The specialty retailer operates in a massive market and continues to see multiple growth opportunities.
• The current valuation is very cheap as it is meaningfully discounted compared to other sports retailers.
• I rate the company as a buy.

Investment Thesis

Academy Sports and Outdoors ( ASO ) has plummeted nearly 30% in a matter of a few weeks, as the pessimistic outlook from other sports retailers such as Foot Locker ( FL ) spooked investors. After the drop, the current price looks like a great bargain. The company operates in a massive market and there should still be ample growth opportunities moving forward. Most importantly, the company’s valuation is extremely cheap at the moment, which should present a meaningful upside unless the macro backdrop were to deteriorate significantly in the coming few months. The company looks really attractive right now and I rate it as a buy.

Market Opportunity

Academy is a US-based sports and outdoor retailer that focuses heavily on value and assortment. The company has a diverse offering that ranges from lesser-known private labels to national brands such as NIKE ( NKE ) and YETI ( YETI ). Sports and outdoors are two massive and ever-growing markets, especially as society continues to emphasize the importance of better health and wellness.

The company estimates its TAM (total addressable market) to be over $175 billion , with the sporting segment growing at a strong 7.9% CAGR (compounded annual growth rate). The market is also quite fragmented with no players having a market share of over 10%, which presents a favorable dynamic for further expansion.

Growth Opportunity

Academy Sports should continue to see ample growth opportunities through new store openings and increasing penetration of its omnichannel business. While the company has grown meaningfully in the past few years, its geographical penetration in the country remains relatively low.

It currently operates 268 stores in 18 states, with most being on the southern side of the country. The number is significantly lower than peers such as DICK’S Sporting Goods ( DKS ), which has 863 stores in 47 states. This presents a massive expansion opportunity, especially in new markets. Given this backdrop, the company is aiming to increase its store count by 50% in the coming few years, which should substantially drive growth.

E-commerce has become increasingly popular in the past few years and the company is adapting to the trend by introducing a better web and mobile platform. For instance, it has been implementing a better search system and a more frictionless checkout system. Since 2018, the number of omnichannel customers increased by over 170% while sales increased by nearly 200%. Besides, 75% of online sales are currently fulfilled in-store, which allows the company to efficiently handle its orders without having to invest heavily in logistics infrastructures and operations.

The penetration of e-commerce should continue to grow in the future. According to the company , e-commerce currently accounts for only 21.5% of total retail sales, and the figure is estimated to rise to 23.6% in 2025. This should continue to provide a solid tailwind for its omnichannel business.

The Focus On Small Details

Academy Sports’ focus on details is also a key to its recent success. The company has made a bunch of small yet sophisticated changes that vastly improve its operations. For example, it redesigned its checkout experience and merchandising presentation , which resulted in better shopping experiences and customer satisfaction. On the back end, it also implemented RFID technology which increases inventory productivity and provides better support for its omnichannel business.

Many of these actions are often very minor and unnoticeable, but together they provide much greater operational efficiency. The management team anticipates more changes in the future which could potentially improve the profitability by over 100 basis points .

Attractive Valuation

After the recent drop, Academy Sports’ valuation looks extremely attractive in my opinion. The company is currently trading at an fwd EV/EBITDA ratio of 4.33x, which is very cheap considering its peer's valuation and its forward growth rate (I’m using the fwd EV/EBITDA ratio in order to account for its debt and the expected decline in EPS this year).

As shown in the chart below, the current multiple is meaningfully discounted compared to other sports retailers such as DICK'S Sporting Goods and Foot Locker. They are trading at an fwd EV/EBITDA ratio of 5.68x and 5.24x, which represent a premium of 31.2% and 21% respectively.

According to Seeking Alpha’s analyst estimate, the company’s EPS is expected to drop slightly this year but should return to double-digit growth in the next few years, which is very upbeat considering the current valuation. If the company can put up numbers in line with the estimates, I believe we can see its multiple reverts upwards to levels similar to peers, which should present a potential upside of around 20% to 30%.

Risk

I believe the uncertainty in regard to the macroeconomy is a potential risk for Academy Sports. As mentioned above, analysts are currently pricing in a slowdown in growth this year but they expect growth to rebound meaningfully next year. However, if the macro environment further deteriorates and we enter a prolonged recession, growth may continue to decline next year, which will put unprecedented pressure on its valuation. I am not too worried at the moment as the unemployment rate remains extremely low at 3.4%, but I believe this is something worth monitoring moving forward.

Investors Takeaway

Overall, I really Academy Sports at the current price point. The company has a huge market opportunity and it should continue to see solid growth through new store openings and the rising penetration of its omnichannel business. The current valuation seems to be discounting its growth potential as multiples remain very compressed. As mentioned above, there should be massive upside potential if the company can return to growth next year.

The company will likely be impacted by the potential deterioration in the economy but the discounted valuation should have already priced in some of the pessimism, which should help limit the downside. I think the current risk-to-reward ratio is very favorable therefore I rate the company as a buy.

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