S&P Global Ratings revised its debt ratings outlook for Academy Sports + Outdoor, Inc. following a debt repayment. The positive rating outlook reflects the potential for an upgrade if Academy consistently performs during an uncertain economy while sustaining low S&P Global Ratings-adjusted leverage of about 1x.

S&P revised its outlook to positive from stable and affirmed all ratings, including its ‘BB’ issuer credit rating. S&P also affirmed its ‘3’ recovery rating on the ‘BB’ rated secured debt but revised the weighted average recovery expectation to 65 percent from 55 percent as a result of lower funded debt.

S&P said in its analysis, “We think Academy’s recent $100 million term loan repayment shows management may pursue a conservative financial policy long-term. We believe Academy could continue to maintain a conservative approach to leverage, noting that management has consistently reduced debt since its October 2020 IPO. For example, the company repurchased $100 million of its term loan in December 2022, resulting in less than $200 million of principal outstanding. This compares to less than half of the original $400 million term loan issuance which ranks pari passu with the outstanding $400 million secured notes. We expect lower debt balances to reduce interest costs while at the same time increasing cash flows over the next year. The December 2022 repurchase follows a $99 million term loan repayment in May 2021 that itself came after deleveraging that occurred with the initial public offering. We believe management could opportunistically reduce debt in the future using internal cash generation. We also expect Academy will likely generate healthy cash flow and project reported free operating cash flow (FOCF) of more than $600 million annually. For the trailing 12 months ended in October 2022, Academy’s S&P Global Ratings-adjusted leverage was 1.3x, or 0.7x on a reported basis. We project adjusted leverage will likely stay at low levels of around 1x over the next year. That said, we see meaningful risks that could lead to higher leverage in the future. This includes an economic slowdown paired with the company’s lack of track record through economic cycles. We also think excess cash flow could be used for shareholder initiatives, including share buybacks.

“Academy’s market position as a value-oriented retailer will likely help support profitability and ample headroom under the credit protection metrics amid a potentially challenging macroeconomic environment. Academy has benefited from its market position as a value-oriented retailer, leading to elevated customer traffic and demand for sporting goods and outdoor equipment, along with capturing trade-down consumers. We believe changes in consumer habits, including more people working from home and continuing outdoor hobbies, will likely provide structural tailwinds to sporting goods demand. We see this all leading to a low-single-digit percent increase in comparable-store sales over the next year or two as compared to the expected mid-single-digit decline in 2022. We also expect an acceleration in new store openings to boost revenue over the coming year. Moreover, Academy’s S&P Global Ratings-adjusted EBITDA margins will likely remain around the mid-to-high-17 percent range over the next 12-to-24 months, somewhat lower than the 18 percent for trailing 12 months ended October 2022. Margins will likely benefit from good inventory management, like what management accomplished in 2022, in addition to cost management and low product promotions. We think these initiatives and other efficiency efforts, including an enhanced loyalty program, an improved website, and good merchandising will likely help sustain margins. We see this occurring despite inflationary headwinds mitigating efficiency efforts over the coming 18 months. That said, Academy does not have a long track record operating with its current strategies. We see this as a potential risk given what we expect to be a mild recession in 2023 while noting the long-term volatility in sporting and outdoor goods.

“We believe management’s operating initiatives will help Academy maintain good performance. Academy’s management team has strategically employed operating initiatives that have helped the company maintain growth and sustain robust S&P Global Ratings-adjusted EBITDA margins. This includes improved in-store service by increasing customer-facing hours, modifying store layout, enhancing the assortment, and increasing merchandise localization efforts. Moreover, assortment and store layout updates, along with good vendor relations, have helped Academy maintain healthy inventory levels, up just 13 percent as of the third quarter ended October 2022 versus the 2021 period.

“In addition, we believe implemented and planned omnichannel initiatives will help maintain customer engagement. Technology management has increased and will likely continue to improve check-out speeds, improve in-store and online search capabilities, and expand payment options. This includes continual improvements to the company’s website and enhancements to the mobile app. We think these initiatives and others like data-driven markdown and merchandising optimization have allowed management to refocus on expansion strategies. We believe Academy will prudently and profitably expand its store base over the next few years, as we project around 10 to 15 new stores annually as compared to management’s target of 80 to 100 new stores by the end of fiscal 2026.

“Academy remains a relatively small, but growing, competitor in the sporting goods retail industry. Academy operates as a regional sports and outdoor retailer with physical stores located primarily in Texas and adjacent southern states, and in our view remains geographically limited in scope. The company positions itself as an everyday-low-price value player and competes with significantly larger and better-capitalized competitors, some of which focus on the mass market or provide specialized sports products. This includes specialized retailers like Dick’s Sporting Goods, Inc., (BBB/Stable/–) and Great Outdoors Group LLC (BB-/Positive/–), mass merchants like Walmart Inc. (AA/Stable/A-1+), and e-commerce competitors like Amazon (AA/Stable/A-1+). We think competing against these larger competitors could increase the risk of a shortfall in sales and limit profitability. In addition, online penetration remains lower than some peers, comprising around 10 percent of total sales. We think this creates potential long-term risks for Academy, as the industry remains prone to product promotions and competitive pricing along with evolving customer habits. We also believe sporting goods and related products remain a highly fragmented sector with increasing competition, including both physical retailers and pure-play e-commerce competitors. We accordingly maintain our negative comparative rating analysis modifier.

“The positive ratings outlook reflects the potential for an upgrade over the next 12 to 18 months if Academy demonstrates consistent performance amid an uncertain economy while sustaining low S&P Global Ratings-adjusted leverage of about 1x.”

Photo courtesy Academy Sports