VCR - Big 5 Sporting Goods: Is The Dividend Safe?

2023-03-27 13:47:58 ET

Summary

• BGFV’s current yield is twice as much as the historical average.
• We examine if BGFV can meet its FY23 dividend bill through internally generated cash flow.
• We close with some thoughts on the technicals and the valuations.

Company Snapshot

Big 5 Sporting Goods ( BGFV ) is a micro-cap stock whose fortunes are linked to the dynamics of the US sporting goods retail industry which has reportedly grown at ~7% p.a . over the past five years. 54% of the product mix consists of hard goods which cover durable items such as exercise equipment, baseball gloves, etc. Soft goods, or non-durable goods (shoes, shirts, other apparel, etc.) account for the rest of the product mix. BGFV’s product portfolio includes not just products from established brands (such as Nike, Spalding, Skechers, etc.), but also includes private label merchandise, and brand name merchandise that is manufactured exclusively for BGFV. Whilst the company does run an e-commerce platform, the bulk of its business comes from the operation of 432 stores across the West-coast region.

The Dividend Angle

I’m not particularly captivated by the core story of BGFV- which is the retailing of sporting goods equipment, but it’s hard to stay indifferent to the dividend yield that comes with the stock. As things stand, you’re looking at a stock that yields an impressive 13.6%, almost twice as much as the 5-year average yield of 7.6% !

Prima facie, that is indeed a tremendous number, but what is BGFV’s dividend policy, and is the dividend susceptible to cuts?

Firstly, investors need to understand that BGFV has quite a lopsided quarterly dividend history ; in recent years we've seen periods where there haven't been any dividends (during the pandemic era) as well as periods where we’ve seen two special dividends come through (in 2021). Basically, rather than having a set dividend policy, linked to, say, a certain target dividend cover, or cash payout ratio, BGFV’s dividend policy is fluid and left to the “ periodic ” discretion of the Board of Directors.

Prima facie, since the board has the flexibility to drop dividends whenever they feel like, and we also have quite a patchy recent dividend history, things don’t bode too well. However, let’s try and examine if the conditions are there to keep the dividend going for the foreseeable future.

The Financial Outlook And The Impact On Dividends

It’s fair to say that BGFV’s top line hasn’t been in the best of health for a while now. Firstly, same-store sales have been on a downward slump in five out of the last six quarters now. Even though the company’s exit rates may likely have benefited from some seasonal winter sales, that isn’t going to be sufficient, and Q1-23 could likely be yet another quarter where BGFV witnesses negative same-store sales growth ( expected to come in at a mid-single-digit decline).

Nonetheless, given the easier comps ahead, one would hope that positive sales growth may be seen during the rest of FY23. Indeed sell-side consensus does expect the company to deliver positive net sales growth of 2.5% for the whole of FY23.

One reason why BGFV may be witnessing volume pressure is that it is averse to engaging in high promotions, unlike a lot of other competitors. Ideally, this should reflect well on merchandise margins, but note that those margins were still down by 129 bps in Q4. Meanwhile, BGFV has also curtailed its impetus towards print advertising spending, and you would hope this would reflect favorably on the operating cost base. All in all, consensus believes the company could witness an 11 bps improvement in the overall EBITDA margin for FY23.

A slightly better operating position should provide BGFV with a decent enough foundation to generate positive operating cash flow. After that, much will depend on how BGFV manages its working capital position which had recently caused significant pressure on the operating cash flow. As noted in the image below, over the last decade, there have been very few instances where BGFV has not been able to convert its sales to positive operating cash flow.

I don’t believe the negative operating cash flow position will last for too long, as the company’s accounts payable position is likely to start contributing positively to cash flow next year (in FY22 it sucked out operating cash to the tune of $37m). Last year, BGFV was not able to stretch its payables effectively as it had to fund its merchandise inventory when supply chain issues eased away.

Nonetheless, historically, over the last five years, BGFV has on average converted over 5% of its sales to operating cash flow. To be conservative if we use just a 4% conversion figure for next year, that would give you over $40m of operating cash flow on the expected FY23 consensus number of $1020m. After spending $13m on CAPEX last year, management now expects to spend up to $20m of CAPEX in FY23. That would leave BGFV with roughly $20m of free cash flow to fund the dividends.

Despite a contraction in the share price, BGFV’s management hasn’t been using the opportunity to buy shares on the cheap, despite having over $21m of repurchase authorization from the board (of t he $25m plan, last year, they deployed only $4.1m and didn’t do any buybacks in Q3 and Q4). This implies that whatever excess liquidity they have will likely go first to the dividends.

If we assume a similar quarterly dividend per share of $0.25 with no contraction in the shares outstanding, that would lead to an annual dividend bill of less than $22m, which would leave BGFV around $2m short from the FCF-related funding. They would then have to dip into their revolver credit facility which they didn’t use last year.

To conclude, if BGFV could get its Sales to OCF (operating cash flow) conversion back to historical levels (of +5%) then they should be able to meet their dividends comfortably by internally generated cash flow (this translates to $30m of free cash flow, taking management’s CAPEX bill guidance of $20m). However, if they are unable to do so, the dividend coverage becomes a lot trickier, and taking on debt when the company already has ample capital leases of $222m does not feel too comforting.

Closing Thoughts- Other Considerations

Despite a rather underwhelming outlook for FY23 (EPS is poised to decline by -0.8% in FY23 to $1.21), BGFV’s forward valuation picture looks reasonable enough. A $1.21 EPS translates to a forward P/E of just 6x, a ~27% discount to the stock’s long-term forward P/E average of 8.2x .

Then, if one is fishing for potential mean-reversion opportunities in the consumer discretionary space, it’s fair to say that the Big 5 Sporting Goods stock could figure high up the table. The stock's relative strength in proportion to the Vanguard Consumer Discretionary ETF ( VCR ) looks relatively overextended to the downside and is currently trading 5x lower than the mid-point of its life-long range.

However, if one looks at BGFV’s standalone weekly chart, one is yet to see any signs of bottom formation; the stock just continues to witness a series of lower lows and lower highs, even as the percent of float that is short continues to scale up every fortnight, since mid- December . There's an outside chance that selling dissipates as the stock has recently dropped to an old congestion zone (between August/September 2020 the stock spent a few weeks building a base within the $5-$8 band)

Nonetheless, until we see a flattening out of the price action, I wouldn’t advise any long positions in this name.

For further details see: