ASO - Academy Sports and Outdoors: Reiterating Buy As Comp Sales Should Improve From Here

2023-09-05 05:40:20 ET

Summary

• I reiterate my buy rating due to management's ability to execute on their strategy and meet consumer demands.
• ASO's management is addressing challenges with big-ticket items by focusing on value and introducing fresh offerings, such as private label products and partnerships with new brands.
• Sales are expected to stabilize and trend upwards, with improvements seen in July and August, and stronger sales anticipated in the second half of the year. Gross margin is also expected to gradually improve.

Investment action

I recommended a buy rating for Academy Sports and Outdoors (ASO) when I wrote about it the last time as I expected management to convince the market that they can continue to execute on their announced strategy during the analyst day, and that evidence of such success will be seen in 2H23 as management navigates the business to meet today's consumers' demands. Based on management's outlook and my analysis, I reiterate a buy rating. I believe that management's current focus on providing value and newness to customers coupled with strong 2H sales forecast and margin improvement will drive ASO's valuation up.

Review

In my 1Q23 analysis, I raised two critical questions. First, how does ASO's management respond to evolving customer preferences towards products with value? Second, will ASO stop the pursue sales of large ticket items considering the current inflationary climate, which has reduced consumers' discretionary spending budget?

At the high level, management continued to acknowledge the ongoing challenges associated with big-ticket items that have longer replacement cycles, such as kayaks and trampolines, echoing a broader industry trend. However, in contrast to previous quarters, management team has taken decisive action to address these challenges through a series of strategic moves. They stated their renewed focus on providing value and introducing fresh offerings, which I believe indicates management responsiveness to changing customer preferences and the sluggish sales performance of high-ticket items. I expect demand to start seeing improvement as the business expands its everyday value offerings to align with the consumer shift towards prioritizing affordability. Specifically, I am very positive about the increasing of presence of private label products, as they are typically more budget-friendly than national brands, which will attract value-conscious customers. Growth should also be further bolstered by management rolling out robust promotional campaigns during key shopping seasons, such as Mother's Day, Memorial Day, Father's Day, and the Fourth of July. I see two benefits from this: 1) sales should improve in accordance to the promotions provided, 2) it would also establish a reputation for enticing promotions that keeps customers coming back. In their pursuit of newness, management is also forging partnerships with new brands and retailers such as L.L. Bean, Escalade, and American Cornhole League, which are expected to launch products in 3Q23. Upcoming partnerships include Fanatics to expand their online selection of licensed team apparel.

ASO reported a 7.5% decline in comparable sales, primarily driven by an 8.3% decrease in transactions. Average Unit Retail [AUR] showed a modest increase, while units per transaction saw a slight dip. However, moving forward, I would expect comparable sales to start to stabilize and trend upwards over the medium term as these strategic shifts take hold. The important point here is that, in 2Q23, in terms of sales progression throughout the quarter, each month showed gradual improvements in comparable sales. Importantly, management observed that the sales trends seen in July continued into August, particularly in important categories like youth apparel, footwear, and backpacks. I expect the strength in sales to pick up towards the end of September, coinciding with Labor Day and the start of the hunting season.

Regarding gross margin, ASO has restated their gross margin guidance of 34 to34.4%, and I expect continued pressure from shrinkage but anticipate that it will be offset by reduced accruals in the second half of the year, resulting in an overall neutral effect. The good news is that ASO should benefit from lower freight costs through the second half of the year, so we should see gross margin gradually improving through the quarters.

Valuation

ASO is generating positive earnings; hence, I am using a forward PE multiple to compare the business against peers. ASO is trading at 7.21x forward earnings today, which is in line with the average multiple that peers' (DICK's Sporting Goods (DKS) and Hibbett (HIBB))are trading at. In 2Q, there is a sequential improvement in comps as compared to 1Q. Management also mentioned that 2H sales will be stronger. With ASO's aligning its business model with customers' preference for value, I believe that they will be able to capture sales growth in the stronger 2H as guided. I expected top line revenue to continue improving and turning positive in 2025. Management also implicitly guided to FY24 non-GAAP net margin of 9%, and I have used that as a benchmark for FY25 and FY26 margins, where I expect it to improve through better inventory and shrinkage management.

The stock is now trading at 7x forward PE, in between its two peers (DKS at 9.6x forward PE and HIBB at 6x forward PE). My take here is that ASO deserves to trade at DKS's level given it has higher net margins and lower debt (ASO D/E ratio is 101% vs DKS's of 161%). However, as DKS is a much larger player in the industry, it deserves a subtle premium. As such, I expect ASO to trade at 9x forward PE, modestly below DKS.

Risk and final thoughts

The potential exists for Nike to restrict or cease product distribution to ASO. If Nike were to view ASO as a less valuable retail partner, this could lead to a reduction or halt in the supply of Nike products to ASO. The absence of Nike products may result in ASO losing customers and market share, potentially having a negative impact on its financial performance and stock price.

While ASO has taken or is in the process of implementing measures to enhance its digital presence and omnichannel capabilities, failing to catch up to competitors in this aspect could lead to a loss of customers and market share over time. Furthermore, the effort to bridge this gap with competitors may result in increased operating expenses, which could adversely affect ASO's financial results

All in all, management addressed the key concerns I mentioned in 1Q23 analysis. They recognized the shift in consumers' preference for value, and they responded according to it. ASO has successfully steered its business towards the right direction. In addition, sales comps are improving throughout the second quarter and management is expecting it to continue into 3Q. On top of improving sales comps, management expects margins to improve as well as they are actively managing its inventory count and shrinkage loss. With many of the headwinds out of the way, ASO's stock price movement will be dependent on how successful is management in executing initiatives. I maintain a buy rating for ASO.

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