Thursday, December 10, 2009

Dick's Sporting Goods (NYSE:DKS): See upside to 4Q09 comp; Upgrade to Buy -Merrill Lynch/BofA

Merrill Lynch/BofA is upgrading Dick's Sporting Goods (NYSE:DKS) to Buy from Neutral with a $28 price target (prev. $23).

According to the firm DKS’ 4Q09 comp plan of (4)-(6)% could be exceeded due to better than expected outerwear in 4Q, given recent colder weather trends. They also believe DKS’ emphasis on target promos (incl. Southern CA for converted Chick’s Stores) is supporting traffic, following 3Q09 traffic up +2.5%, the 1st increase since 2Q07. Finally, while the Guns & Ammo category should be a comp drag against tough comparisons (NICS background checks in Nov 09 was -20% y/y), better golf category (~20% of sales) comps and margins against very easy comparisons should be more than an offset (Golf Galaxy starts to anniversary 3 quarters of DD% comp declines this 4th quarter, with 4Q08 comps down -20.7%, driven by last year’s strong clearance activity). Merrill notes they have bumped their 4Q09E EPS to $1.15 (from $1.10) and now assume flattish instead of (3)-(4)% 4Q comps.

Expect 2010 rebound from trough margins in 09
DKS’ operating margins should rebound from current depressed levels (Merrill is forecasting a 2009 EBIT margin of just 5.2%), supported by continued inventory management and store level initiatives, including the conversion to self service footwear departments. However, increased depreciation costs associated with a new corporate HQ and potential incremental ad spend related to new markets could impact the magnitude of the rebound in 2010.

Share gains continue; Opportunity for sq ft growth remains
DKS should gain market share from regional competitors and has accelerated its expansion plans in the Pacific Northwest, following the closure of Joe’s Sporting Goods. DKS should maintain 6+% sq ft growth in 2010 and beyond given the opportunity to operate 800+ Dicks Sporting Goods stores in the US (vs. just 420 at the end of 3Q09).

Valuation: Attractive entry point following recent pullback
Following a 17% pullback from October highs, DKS is currently trading at 16.4x Merrill's F2011E (FYE Jan) EPS of $1.30. They are upgrading DKS to Buy and raising their PO to $28, which is 21-22x their F2011 EPS of $1.30. While DKS’s historical 5-yr forward P/E average is roughly 18x, DKS has traded within the range of 21-23x forward P/E during times of sales and margin expansion, and Merrill's outlook should be supported by 1) upside to 4Q09 comp sales guidance 2) expected margin rebound from trough margins in 2009 and 3) continued market share gains and opportunity for accelerated square footage growth.

Notablecalls: The Dick's upgrade from Merrill/BofA probably represents one of the strongest calls we have this morning. I like this call as it's not purely a valuation one:

- Merrill highlights the possibility of better-than-expected comps.

- They see rebound in margins in 2010 helped by new initiatives.

- Dick's looks to have become a formidable force in their space & there seems to be ample room for futher growth.

The stock is down 4-5pts from its yearly highs and there's a 13%+ short interest in the name.

All in all, I think DKS can trade towards the $22.50-23.00 range today. Anything below that is a screaming buy.

1 comment:

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