2023-07-12 17:14:49 ET
Summary
- Big 5 Sporting Goods' stock has experienced a loss of about 18.7% in the last 11 months, compared to an 8% gain for the S&P 500.
- Despite a challenging macro environment, the company's dividend is considered sustainable and the shares are reasonably priced, but the company predicts 2023 will be a tough year.
- The company's cash flow and dividend health are considered strong, but I will not be adding to my position due to the company's cautious outlook.
It’s been about 11 months since I announced to the world that I was still long Big 5 Sporting Goods Corporation ( BGFV ), and in that time the shares have returned a loss of about 18.7% against a gain of 8% for the S&P 500. That’s troublesome, obviously, but it’s time to check in with this stock to see if it makes sense to buy more, hold, or take my lumps and move on. I’ll make that determination by looking at the financial results that have come out since I last wrote about the name, and by looking at the valuation. Before that, though, I’m going to offer a very brief summary of the most recent earnings conference call to offer some context to the following analysis.
Welcome to the “thesis statement” portion of the program. This is where I offer you the gist of my thinking, if it wasn’t clear enough to you from the title and bullet points above. I do this so you won’t be obliged to read through the entire article, and thus save you time. You’re welcome. I think the dividend is sustainable here, and that’s supportive of price, and offers predictability to shareholders that they may not always get. At the same time, the shares are very reasonably priced at the moment, so if I didn’t have a position here already, today would be the day to rectify that problem. I’m not going to add to my position, though. The company itself is telling the market that 2023 will be a challenging year, and I see no reason to disbelieve them. I like the risk free capital structure, and the reasonably well covered dividend here, and so I will hang on. For new capital, though, I will find safer, lower yielding government bonds.
I think a few interesting things came out of the most recent earnings call, and I’m going to offer them to you so you won’t have to read the transcript .
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The company achieved mid-point guidance range, despite a challenging macro environment.
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Weather was a bit of a challenge, but the lackluster macro environment was a significant challenge for the firm (including the negative impacts of the regional bank crisis, and lower tax refunds).
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The company is managing inventory much better than the pre-pandemic era, as a result, merchandise margins up several hundred basis points from that period.
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The current state of the world remains a challenging environment, and Q2 is off to a soft start, with sales down 11% from the year ago period as of the date of the call. That written, second quarter results revolve around high volume periods like Memorial Day, Father’s Day, and the start of summer, and the company is guiding lower by the high single digits from the year ago period.
So, I think the combination of tough comparisons and a challenging macro environment are going to continue to weigh on this business, and impressions about growth potential. I’ll examine the financials with that as context.
Financial Snapshot
Before comparing the most recent quarter to the same period last year, I want to write about what 2022 was like. I’d say that the year 2022 was mixed or great, depending on your frame of reference. If you compare it to 2021, you’re going to be disappointed, since revenue was down 14% and net income was lower by an eye watering 75%. The full year 2022 was great relative to the pre-pandemic era, since net income last year was about 209% higher than it was in 2019. The capital structure has improved massively since then also, with cash in 2022 higher than 2019 by 210%, and total liabilities down by fully 13.5%. So, the trend here is either “good” or “bad” depending on where you choose to start the analysis.
Turning to the most recent quarter, I think we can safely say that the trend observed above in some ways persists. The capital structure for the first quarter of this year was in some ways worse than it was at Q1 2022. Total liabilities are down $24.6 million from the year ago period, but cash is down fully $34.5 million. That written, the debt free balance sheet remains rock solid at the moment. This is a rarity at the moment in my experience. That written, the capital structure today is much, much better than it was in 2019, with cash today up by 418%, and total liabilities lower by 8.4% than the Q1 2019 period. Revenue and net income for the first quarter of this year were soft relative to the same period last year, and relative to 2019, though. Given what the company said on the conference call, I’m not sanguine that this will change anytime soon.
More important than all of this, though, is the sustainability of the dividend. While I’m normally a fan of accrual accounting, when it comes to dividends and their sustainability, I look at cash flow. Given that the company generated $12.3 million in cash from operations for the quarter, while spending only about $6.1 million on dividends gives me some measure of confidence. Additionally, I think it’s worthwhile pointing out that since 2014, the company generated $424.4 million cash from operations, while spending $152.8 million on dividends. I’ve also observed that cash from operations has been fairly steady, with only two negative years (2022 and 2017) of the past nine. Given the above, I’m actually pretty comfortable with the health of the dividend, and would be willing to buy more shares at the right price.
The Stock
If you're one of my regular readers, you know what’s about to happen. I’m about to point out, yet again, that I consider the stock and the business to be different things. I've written my reasoning so often that I worry about boring my regular readers. This won’t stop me from writing it again, though, because your potential boredom is a price I’m willing to pay. The business generates money by selling sporting goods and accessories. The stock represents an ownership stake in the business, but because it’s driven by the crowd, the price moves up and down more than what is reasonable in my estimation. In my view, the up and down price movements often reflect more about the mood of the capricious crowd than it does anything to do with the business. Additionally, when the crowd does react to what's going on at the firm, it often overreacts, and these overreactions are the source of potential profit, in my view.
To highlight this reality using this stock, let’s imagine there are two investors, each of whom decide to buy this stock based on the exact same level of awareness about what’s going on with the business. One buys on February 17 of this year, and is currently down on their investment to the tune of about 4%. The second person gets distracted, and buys exactly one month later, and is up about 29% since then. Not enough happened at the firm to warrant a 33% change in return over one month. The stock really matters, and I only ever want to buy from investors when they’re relatively skittish.
Another word for "relatively skittish" is "cheap", which is why I really like buying cheap shares. I measure cheapness in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of market price to some measure of economic value like earnings, free cash flow, and the like. I want to see a stock trading at a discount to both the overall market and its own history. When I last reviewed Big 5, the shares were trading at a price to sales ratio of about 0.23, and the stock was yielding 9%. Fast forward to the present and here’s the current lay of the land. The shares are actually about 5% cheaper, and the dividend yield is about 14% higher than it was previously.
Source: YCharts
Source: YCharts
I’m certainly not going to sell, based on the fact that this reasonably secure dividend is currently yielding about 645 basis points over the 10-year risk free rate at the moment. I consider that to be a reasonable premium. As I wrote above, I want to use relatively simple and more complex tools to work out what the market is "assuming" about a given company's future. Ratios are one of the more simple ways to explore this. I also apply a bit of high school algebra to the task, and employ methods described in books like "Accounting for Value" by Penman, and "Expectations Investing" by Mauboussin and Rappaport. Both of these books introduce the idea that stock price itself offers a wealth of information about growth assumptions. The greater the assumptions about future growth, the more risky the investment. Applying this way of thinking to Big 5 suggests the market is assuming that this company will be bankrupt within five years. Now, I understand that there will be headwinds, but I think this is excessive.
Given the above, I’m neither going to sell nor add to my position here. I want to preserve capital, and I’m happy earning the rates on offer from government bonds. If there was some hope that Big 5 would have a great growth spurt sometime soon, I’d add to my position, but the company itself is being cautious. For that reason, I’m holding, and not adding to my Big 5 position.
For further details see:
Big 5 Sporting Goods: Staying In For The Dividend