Dick’s Sees Margin Pressures Lingering Well Into 2018

Shares of Dick’s Sporting Goods eased 73 cents, or 2.8 percent, to $25.59 on Tuesday after the chain warned that 2018 earnings could decline by as much as 20 percent due to continued gross margin pressure, expected flat comps and ongoing investments.

The cautious outlook was somewhat offset by its report of a down but better-than-projected third quarter and its inference that its guidance remains the same for the fourth quarter.

On a non-GAAP basis, net income in the third quarter dropped 40.5 percent to $31.9 million, or 30 cents. Non-GAAP earnings exclude the benefit from a multi-year sales tax refund in the latest quarter and conversion costs for former Sports Authority (TSA) stores in the year-ago quarter.

Net earnings slid 24.5 percent to $36.9 million, or 35 cents a share, exceeding the company’s expectations provided on August 15 of 22 cents to 30 cents per share.

Sales expanded 7.4 percent approximately $1.94 billion. Consolidated same-store sales slid 0.9 percent, compared to the company’s guidance of a low-single-digit decrease. Third quarter 2016 consolidated same-store sales increased 5.2 percent.

E-commerce sales in the quarter expanded 16 percent and accounted for 10.3 percent of total sales, compared to 9.6 percent during the third quarter of 2016.

“As expected, the environment was competitive and promotional,” said Ed Stack, chairman and CEO, on a conference call with analysts. “While we were pleased to deliver continued growth across key businesses, such as golf, our private brands and athletic footwear, other categories including hunting and electronics remained under pressure.”

Golf and its private-label business remained strong in the quarter, each comping positive double digits. Athletic footwear comped positive low single digits after anniversary-ing the bulk of its premium full-service footwear deck expansion in the spring.

The hunting business declined double digits due to weak overall demand and excess inventory in the channel. However, comps sequentially improved throughout the quarter as Dick’s believes it began to capture displaced market share from the Gander Mountain closings. Electronics, which is primarily fitness tracking, “continued to be very soft and with a general lack of newness and innovation. We expect this trend to continue into the fourth quarter,” said Lee Belitsky, CFO, on the call.

In addition, the anniversary of favorable teams competing in last year’s Major League Baseball playoffs pressured comps during the quarter. While sales of Houston Astros merchandise performed well, those sales did not roll into its comp base given that the stores opened less than 14 months ago. The headwind in its license business is expected to continue into the fourth quarter as it anniversaries the Chicago Cubs 2016 World Series championship.

Gross margins were down 307 basis points in the third quarter due to lower merchandise margins.

Stack said that as expected, merchandise margins were under pressure in the “highly-promotional environment” although in line with management expectations. Said Stack, “We feel we continue to gain market share from our traditional competitors and will continue our current strategy and tactics to protect market share through the fourth quarter and throughout 2018.”

In reporting second-quarter results on August 15, Dick’s slashed its guidance as Stack said at the time that the retailer planned to be “more promotional and increase our marketing efforts for the remainder of the year, as we will aggressively protect our market share.” Its EPS guidance was cut to a range of $2.80 to $3.00 from $3.65 to $3.75.

Dick’s margins in the third quarter were also impacted by occupancy deleverage and higher shipping and fulfillment costs as a percentage of sales.

SG&A expenses were 24.48 percent, down 56 basis points from the same period last year. The improvement was driven primarily by its new in-house e-commerce operating model, lower incentive compensation and other expense reduction initiatives. Pre-opening expenses also leveraged 65 basis points as it opened fewer new stores in 2017 and did not open any major new markets.

Total inventory increased 4.1 percent at the end of the third quarter, below its 7.4 percent sales growth in the quarter.

For the fourth quarter, Stack said the company expects the retail landscape will be “fiercely competitive” and he sees no lessening in the margin pressures.

“With excess inventory still in the supply chain, broadened distribution strategies from some key vendors and a lack of newness and innovation, the fourth quarter and 2018 will continue to be promotional and pressure margins from last-year levels,” said Stack.

Looking further ahead, Stack said the company sees “tremendous opportunity in our industry as it continues to evolve” and plans to make “significant investments” in the fourth quarter and next year to support those opportunities.

“This will have a short-term negative impact on our earnings,” stated Stack. “However, we expect these investments will pay meaningful dividends in the future.”

Increased investments are planned in e-commerce, as well as technology in its stores and store payroll to enhance the consumer experience. “Meaningful investments” will also be made in Dick’s Team Sports HQ and in the development and support of its private brands. Given these investments, continued gross margin pressure and approximately flat comp sales, EPS “could decline as much as 20 percent in 2018,” said Stack.

As part of those investments, Paul Gaffney will be joining the company as EVP and chief technology officer and will oversee infrastructure, e-commerce platforms and its digital platforms. He most recently served as SVP of information technology at Home Depot responsible for the organization software and engineering applications. Stack added, “I’m pleased to welcome Paul to the executive leadership team and am confident he will be instrumental in driving our digital transformation efforts.”

At the store level, increasing investments will be made to support training, faster checkout, more payroll, enhanced ship-from-store capabilities and more opportunities for customers to buy online and pickup in the store. Said Stack, “We are putting the consumer at the center of everything we do.”

Driving differentiation and exclusivity within assortments, particularly with its own private brands, will remain a focus. “Significant investments” will be made into Calia, Field & Stream, Top-Flite, Walter Hagen and new brands that will be launched in 2018. Dick’s continues to expect its private brands to reach approximately $1 billion in sales this year and “believe it can double over a relatively short time,” said Stack.

Dick’s Sports HQ is seen as a “multi-year initiative” that the company expects will provide a “tremendous amount of data and an opportunity to establish new revenue streams.”

Stack concluded around the accelerated investments, “We love the position we occupy in the industry. The disruption in this space is a great opportunity for Dick’s Sporting Goods. We make these investments from a position of strength. Other than seasonal borrowings, we have no significant long-term debt, we have significant cash flow and a brand that is the largest and most profitable full-line sporting goods retailer in the country. We make these investments because we believe in the future of our business. We believe we are uniquely positioned in the industry to not only continue to lead, but to widen the leadership position we hold today.”

In her first conference call with analysts since being promoted to president, Lauren Hobart echoed Stacks’ sentiments about the strength in the retailer’s business model.

She said, “Dick’s Sporting Goods is a great company. We are an incredibly strong brand and we have a real purpose in that we believe that sports make people better and that we play a crucial role in the lives of our customers.”

Hobart added, however, that retail is “changing at a very rapid pace” with consumers having many shopping options available to them. Hobart added, “We have to make coming to Dick’s or shopping at Dicks.com an amazing experience. And to win, we recognize we have to invest in our business.”

Part of those customer-centric investments include the launch this past summer of its Best Price Guarantee, whereby Dick’s will match prices from competitors. She added, “And over the next several quarters, we’ll be making other key investments to allow us to deliver those improvements.”

For example, one change to its ScoreCard loyalty program is stopping expiring accrued ScoreCard points at year-end as it has in the past. In 2018, it will move to a rolling 12-month expiration.

“While there is an initial cost to making these improvements, we believe this is the right investment in our rewards program because it will help reduce the point of customer frustration and will provide us an opportunity to drive customers back to the store after they earned their points by shopping with us during the holiday season,” said Hobart. Dick’s will also be launching a new tier of its ScoreCard program for its most-frequent customers.

The fourth quarter will include a charge of 7 cents a share to support changes in its ScoreCard loyalty program.

The chain’s renewed focus on the customer will be underscored in its upcoming holiday campaign. Said Hobart, “This campaign reinforces the benefits that come when you give a gift of sports, like leadership, confidence and togetherness, while also promising enhanced customer service, reduced lines and other benefits that we will offer to our customers this holiday season. As Ed said, we are very excited about our business. We are embracing the future and making the investments needed to continue transforming to meet our customers’ ever-changing needs.”

While warning on earnings for 2018, Dick’s slightly raised its guidance range for the current year due to the third-quarter beat. GAPP EPS is now expected in the range of $2.95 to 3.07 versus a range of $2.85 to 3.05 set in August. Non-GAAP EPS is projected in the range of $2.95 to 3.07, up from $2.80 to $3.00 previously. Same-store sales are still expected to be in the range of flat to a low single-digit decline for the year compared to an increase of 3.5 percent in 2016.

For the fourth quarter, GAAP EPS is expected between $1.05 to 1.17, well above earnings of 81 cents a share in the same period a year ago. Non-GAAP EPS is expected between $1.12 to 1.24 excluding the charge for changes in its ScoreCard loyalty program, which is down from $1.32 in the fourth quarter of 2016. Same-store sales are currently expected to decline in the low single-digits compared to an increase of 5.0 percent a year ago.

Regarding 2018, Belitsky reiterated that the company anticipates “the retail environment will remain challenging throughout next year,” and expects approximately flat comps and EPS to decline “as much as 20 percent.”

In line with its plan to slow expansion announced earlier in the year, Dick’s expects to open between 15 and 20 stores in 2018 compared to 59 in 2017. Net capital expenditures are anticipated to be between $250 million and $300 million compared to its guidance of approximately $400 million this year. In 2016, capital expenditures were $242 million.

The company said that beginning in 2018, it will still provide annual guidance but stop reporting quarterly guidance. Said Belitsky, “We believe this approach more closely aligns with industry norms, and importantly, the longer-term view we take while planning and managing our business.”

In the Q&A session, Stack said the company decided to share some insights into 2018 guidance because it felt investors had a right to know the investments would be coming. Said Stack, “We knew the impact it was going to have on our earnings, and felt that it was the right thing do for our shareholder base and people who may want to invest in the company.”

Asked to elaborate on some categories, Stack said he expects hunt should improve in 2018 as last November’s election are anniversaried. He added, “I don’t know if it gets better, but it gets less bad.”

He said golf should continue to do well. He added on golf, “That was a great product cycle this year. We think that that’s going be good next year also.”

Among brands, he said Dick’s will “continue to invest heavily in the Adidas brand. They’ve done a great job.”

But overall, Stack said the company expects comps to be flat “because the industry is just relatively flat” and asserted its investments will pay off with growth in coming years. Said Stack, “We think we will continue to widen our position in the industry. We think this disruption is really good for us long term, a little painful right now, don’t get me wrong, but we think it’s good for us long-term.

Asked about Nike’s plan announced at its recent Investor Day to shift the wide majority of its sales away from “undifferentiated” retailers, Stack said, “I think it’s actually beneficial for us. I think that we’ve got a great relationship with our brands. We see that we’ve got access to differentiated product that we didn’t have access to before. Part of that’s come through some of the investments that we’ve made in our business, including the full-service footwear platforms. But we actually think that longer term, it’s good news for us.”

He believes the industry will remain promotional largely “because there’s just too much inventory sitting in the pipeline.” This is due to brands becoming more widely distributed and discounted, including on their own websites.

But he also said the industry also needs “to bring product to the marketplace that is more innovative” to drive more full-price selling and lift margin rates. Stack added, “We see some brands that have brought some innovation and excitement into the marketplace, so we’re bringing that in, in 2018. Some others aren’t. The ones that are, we’re going to focus on and try to drive that business. And others that haven’t, we’re going to continue to probably downplay some of those guys.”

Photo courtesy Dick’s Sporting Goods