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Analysts Are Ignoring Future Pricing Problems at Dick's Sporting Goods


The consumer economy and competing stores could present problems for the retailer..

I think that Dick's Sporting Goods (NYSE:DKS) is about 12% to 20% overpriced, and I believe that analysts are ignoring future pricing problems.

At $53, the stock's current price, Dick's discounts a 15% five-year EPS growth rate. That is based on FY14 and FY15 EPS of $2.63 and $3.09, respectively. In that calculation, I use a 4.2% risk-free rate (3.7% long Treasury plus 50 bps to counter the Fed's quantitative easing). I also use a 7% risk discount and a 1.5% terminal growth rate.

The sellside consensus growth rate is also 15% -- a huge red flag since companies almost never achieve sellside long-term growth rates. With that 15%, the sellside consensus price target is $58, which was reiterated by many sellsiders after the recent analysts' meeting in Pittsburgh.

To get to $58, you have to use use the Fed's 3.7% long Treasury with no adjustment (take the quantitative easing Kool-Aid) or use a 6.5% risk discount, which I see as too low for a non-oligopoly seller of very discretionary hard goods and what's increasingly becoming fashion apparel. (Yes, I know Nike (NYSE:NKE) and Under Armour (NYSE:UA) would dispute this.)

The financial highlights of management's five-year plan start with growing the Dick's store base to 800 in 2017. The total store CAGR (compound annual growth rate) is to be 9.5%, including the rollout of the new Field and Stream concept, which sort of clones Bass Pro or Cabela's (NYSE:CAB). A 2.5% same-store sales number, excluding e-commerce, is expected at the core Dick's stores. E-commerce is growing at 60% with a target of 10% of sales in 2017.

Management reminded analysts that its stores open at 90% productivity, rather than the 70% that is more common of other retailers. A 10.5% EBIT (earnings before interest and taxes) margin is expected, up from 9% now. That will come from 60 bps of gross margin expansion and 90 bps of SG&A leverage. Occupancy leverage averages 15 bps per point of comp store sales and SG&A leverages at a 1% to 2% comp store sales rate, something that does suggest higher operating margin potential.

But I have a problem with this outlook, and that is the consumer economy and what I know of present competitive conditions. With the exception of the golf category, which represents 20% of sales with no industry growth, Dick's sells a disproportionate amount of merchandise to under-30-year-old consumers, and probably most heavily to customers under age 25. In this category, we see teen fashion retailers with terrible sales, as very cheap alternatives such as Forever 21 and H&M (STO:HM-B) become more dominant. College costs and debt are becoming bigger issues to this demographic. They see many of their contemporaries not getting jobs. Car ownership is low and many live with their parents. Last week, I saw more evidence of consumer pressure in the economy as a whole, as Nielsen data showed that branded food companies' price promotions are increasingly very ineffective.

Regarding Dick's, it has run into some pricing pressure in the South from Academy, a very strong competitor tdicks sporting goodshere. I have not seen specific pricing studies but I have reviewed anecdotal evidence from Internet comments and results from Consumer Reports surveys showing that consumers believe that Dick's prices are higher than Academy's. I am certain that Academy is priced lower, though I do not know by how much.

Dick's management has also said that it and its suppliers will be developing more opening price point merchandise for its stores. Also, Dick's will be moving more of its square footage into selling apparel for women and children, an area of retailing that has more competition than sporting goods and consumers with less need for, or appreciation of, sweat-wicking properties or "charged cotton."

So I would not expect that there would be no increase in gross margin over five years; instead I would expect a decline. I would also expect closer to 30 bps of SG&A leverage as I believe that sales from new openings in less well-to-do and more price competitive areas of the country will probably hurt sales growth at the margin.

I expect a five-year compound average EPS growth rate of around 12%, if gross margin holds, which could easily be questioned. I believe that the stock is worth $47, but again, that's if gross margin holds.
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