Citi Research upgraded Dick’s Sporting Goods rating to “Buy” from “Neutral” and raised its price target to $280 from $220, citing that the merger of Dick’s and Foot Locker “will be a powerful force in the world of athletic footwear and apparel” and its analysts listed 10 reasons for confidence in the merger.

Citi’s lead analyst, Paul Lejuez, also increased his earnings estimates over the next three years to reflect the inclusion of Foot Locker’s business and related synergies.

Citi analysts Top 10 reasons include:

  1. Category killer in U.S. athletic retail with broad offering and significant synergies: Combined, Dick’s will have roughly $22.5 billion in sales, according to Citi’s estimates, including about $20 billion in U.S. sales, with the next category-specific player within the U.S. being JD Sports, at about $4.3 billion. Lejuez said, “We can’t go so far as to say they are the only game in town, but we think it is safe to call them a category killer within the US. And, unlike many other segments of retail that have two or three dominant players (think home improvement, warehouse clubs, off-price), there really aren’t any others that belong in the same category as DKS.” Lejuez also stated that while Dick’s has forecasted $100 million to $125 million in synergies over the medium term from sourcing and direct procurement efficiencies, additional synergies are likely to be realized as corporate functions, such as finance and technology/IT, are consolidated.
  2. Dick’s has a healthy customer base and sells many need-based products: Dick’s tends to have a higher-income customer base than many of its competitors, who have “been healthy and spending consistently over the past several years.” Products sold at Dick’s also carry a more “needs-based component,” such as equipment required for youth sports, making them less discretionary than many other categories at retail. Lejuez said, “While the Foot Locker customer base tends to be more economically sensitive than the Dick’s customer, there are opportunities that come with scale to help improve the assortment within Foot Locker stores to better cater to that customer.
  3. More scale with their largest partner, who is becoming a better partner: Combined, Nike represents 36 percent of the sales of Dick’s and Foot Locker, with the combination representing 32 percent of Nike’s U.S. wholesale business. Dick’s gains more negotiating power at a time when Nike is seeking to better partner with retailers, including being more open to absorbing margin hits on slow sellers. Said Lejuez, “NKE’s friendlier stance toward its retail partners is good news in general, as it should result in a more consistently healthy marketplace. And no partner is more important to NKE than DKS, as the distribution of NKE product through Dick’s and Foot Locker stores is key to NKE finding its way and connecting with customers.”
  4. A cheaper way to get exposure to a potential NKE turnaround: Lejuez noted there’s a “significant debate about whether NKE can achieve consistent topline growth and significantly improve its EBIT margins.” He said Citi remains “Neutral” on Nike less due to turnaround concerns, but the “risk/reward of making that call” with Nike’s shares trading at an F26E P/E multiple of 36x. With DKS trading at an F26E P/E multiple of 14.7x, “we believe it is a cheaper way to have leverage to a NKE turnaround without being completely dependent on a NKE turnaround.
  5. Not completely dependent on a NKE turnaround: Lejuez noted that Dick’s has outperformed in recent years despite the challenges facing its largest brand, Nike. Lejuez added, “FL was more pressured, but we believe there will be less pressure on the FL in the future under DKS management (as a combined entity) and considering how NKE is changing its relationship with its partners.”
  6. Brands want to work with DKS: Lejuez noted that upstart brands, such as Hoka and On, as well as established brands undergoing resurgence, like Asics and New Balance, “all seem to think of DKS as a key retail partner.” He also noted that Arc’teryx (footwear only) and Salomon footwear are testing Dick’s distribution, and the Free People Movement apparel brand, owned by Urban Outfitters, is expanding Dick’s doors. Lejuez said, “The DKS House of Sports and Field House concepts are unique/special within the retail landscape, and we can understand why most brands believe the DKS stores are the best way to represent their brand. While FL has many mall-based stores that are not as unique as the DKS store portfolio, we believe that under DKS management, we are likely to see FL store standards get stepped up.”
  7. GameChanger and Dick’s Media Network are drivers of growth and margin: Both GameChanger and Dick’s Media Network are expanding, high-margin businesses. Lejuez believes Dick’s ScoreCard and Foot Locker’s FLX loyalty programs will eventually be combined to expand reach for those seeking to target active lifestyle consumers. Lejuez said, “This DKS/FL combined entity is likely to be an increasingly attractive advertising alternative for brands.”
  8. Opportunity to improve/rationalize Foot Locker real estate: Lejuez said Dick’s team will likely “view store rationalization decisions through a different lens,” including being more open to closing Foot Locker banner stores in the same location as a Dick’s. The analyst suggested Dick’s could offer coupons to shoppers at the closing Foot Locker banners to help convert former Foot Locker fans to DKS shoppers. Lejuez also sees an opportunity to close Champs. Lejuez said, “Champs has had an even tougher several years than Foot Locker stores from a sales perspective, and we view the concept as less differentiated within the retail landscape.”
  9. Private label opportunity within Foot Locker stores: Foot Locker has historically underperformed in private apparel and stands to benefit by introducing some of Dick’s store labels, such as Calia and DSG, to complement its apparel offerings from Nike, Adidas and other national brands. Lejuez wrote, “If successful, this could be a nice driver of sales productivity within FL stores, and gross margins on private brands are 700-900bps higher than national brands, acting as another margin driver for DKS.”
  10. Attractive valuation with multiple expansion potential: Lejuez said Dick’s is trading at an F26E P/E multiple of 14.0x and F26 EV/EBITDA multiple of 8.3x, favorable to other “category killers,” such as Home Depot, Walmart, Costco, AutoZone and TJX Cos. Lejuez said, “Sales growth is typically in-line relative to this group average, yet the multiple is half. We see an opportunity for the market to give more credit (award a higher multiple) to DKS over time, especially if they can show traction (and lack of distraction) with the FL business.”

Image courtesy Dick’s Sporting Goods