Citi Research downgraded shares of Dick’s Sporting Goods to “Neutral” from “Buy” due to margin concerns tied to the need to clear overall excess inventory in the marketplace.

The update arrived as Dick’s will report its fourth-quarter results on March 7.

Citi lowered its EPS estimates for Dick’s DG for the fourth quarter to $2.98 a share from its previous estimate of $3.22 a share. The revised Citi EPS estimate is still above consensus targets of $2.90. For fiscal 2023, Citi’s EPS estimates were reduced from $11.53 to $11.41 a share, below consensus targets of $12.01.

Citi still expects Dick’s results will exceed analysts’ consensus EPS targets in the fourth quarter due to stronger sales but anticipates gross margins will come below consensus.

In the note, Citi’s lead analyst in the space, Paul Lejuez, said he believes Dick’s had to be more promotional in the quarter to clear elevated apparel inventory levels and those efforts were undermined by warmer weather in the Northeast and Midwest this holiday and into January. The analyst said, “Several data points suggest that the athletic apparel environment was extremely promotional this holiday, and it took deeper markdowns to clear through excess inventory.”

The analyst also suspects Dick’s will take a “very conservative approach” to 2023 EPS guidance due to promotional pressures and likely will guide below current consensus targets of $11.41.

The analyst pointed to reports from Under Armour, Lululemon, Adidas, and Walmart suggesting elevated markdowns and still excess apparel inventory in the marketplace. Specifically, he highlighted Lululemon

reporting weaker-than-expected margins in the fourth quarter and elevated inventories at the quarter’s close, and Under Armour’s similar markdown pressures in the fourth quarter and warning of a highly-promotional environment in the first half of 2023. Adidas, according to Lejuez, also indicated 2023 would be a “very weak, rebuilding” marked by a focus on inventory clearance.

Lejuez said he believes the investor focus will be on FY23 guidance given the difficult multi-year comparisons Dick’s faces and anticipated markdown headwinds expected in the first half as elevated athletic apparel inventory in the marketplace is worked through. Lejuez added, “With DKS up against difficult multi-year comparisons in 2023 (esp. 2H), it’s tough to see how they can sustainably grow sales/EPS, particularly if demand slows in key categories of apparel/footwear.”

On other points, Lejuez said he’s interested in hearing from Dick’s management on its fourth-quarter analyst call about their long-term margin targets, given the return of promotions. Citi estimates FY23 EBIT margin of 10.8 percent versus an estimated 12.3 percent in FY22 and compared to 16.6 percent in FY21 and 5.1 percent in the pre-pandemic FY19.

He also is interested in hearing whether Dick’s is planning assortment changes given the inventory challenges faced last year by their two largest vendors, Nike and Adidas.

Lejuez’s note also issued concerns that Dick’s newer concepts “may be falling short of plans” as both House of Sport and Public Lands weren’t highlighted in the third-quarter quarterly call’s prepared remarks. Lejuez also saw the news last week that Dick’s plans to acquire Moosejaw from Walmart as a sign that Dick’s may be looking for new growth vehicles. Achieving sufficient growth may be more challenging given Dicks’ “significantly larger sales base” amid ramped-up growth in recent years, he noted

Lejuez nonetheless continued to view Dick’s as a “market share winner” that will likely continue to outperform the industry. The analyst said on his investment stance, “After making strategic investments in omnichannel capabilities, DKS emerged from Covid in a much stronger position, allowing them to take advantage of market share up for grabs in the industry. With DKS sales base [about] $3.5BN higher than pre-Covid levels, we believe it will be more difficult for DKS to expand sales and EPS over the next few years, making the risk/reward more balanced at current levels.”

Citi’s price target on Dick’s was lowered slightly, from $143 to $140, reflecting the reduced estimate. Shares of Dick’s in mid-day trading Tuesday were up 36 cents to $130.12. The stock began the year at $120.29 and its 52-week range is between $63.45 and $138.43.

Photo courtesy Dick’s SG