Morgan Stanley raised its price target on Dick’s Sporting Goods to $30 from $28, believing the “company and stock are at a pivotal moment.”
In a note to clients, Simeon Gutman, Morgan Stanley’s lead analyst, said the stock has rallied about 25 percent since taking a hit in early November at around the time the retailer reported third-quarter results and announced that 2018 earnings could decline by as much as 20 percent due to continued gross margin pressure, expected flat comps and ongoing investments.
The analyst said those investments in labor, technology, e-commerce and pricing “should better position” Dick’s as an omni-channel retailer while also driving traffic and loyalty.
He added, however, “The big investment question that investors seem to be trying to gauge is whether a down 20 percent EPS year in 2018 (the big reset) is the last one or if another wave of investments is possible in 2019.”
The note followed a meeting by Morgan Stanley’s team and key members of Dick’s management.
On the downside, the analyst noted that the overall the sporting goods and apparel environment “seems tepid overall” due to a lack of product innovation, heightened brand proliferation across channels and ongoing struggles in hunting categories. Gutman wrote, “There do not appear to be identifiable drivers on the horizon that could stimulate the sector.”
A “few bright spots” for Dick’s business includes its private brands, golf, footwear, Yeti coolers and recent success with Patagonia.
The analyst also noted that when Dick’s management was asked what inning of its omni-channel transformation the business was in, they indicated the third. Focus areas include adding allocated space in stores and dedicated parking spots to support in-store pickup, increasing the speed of online deliveries, improving website functionality and rolling out a new mobile app.
Gutman wrote, “As we have seen for most retailers omni-channel transformations tend to take longer and be more expensive than initially planned.”
On the positive side, he said private brands “have been growing nicely and should be a major driver of growth.” Representing 11 percent of sales, private labels are expected to reach $1 billion by year end and $2 billion in the medium term. Morgan Stanley expects new private label lines in the outdoor apparel and hunting equipment categories in 2018 to join the success of the Calia women’s apparel brand, Field & Stream and Reebok apparel, as well as two brands introduced this year, Second Skin compression apparel and Ethos fitness equipment. He noted that private labels generally are providing a 600 to 800 higher gross margin payback versus branded products and provide a differentiator against online sellers that carry many of its major branded partners.
Gutman also expects Dick’s acquisitions over the last year of Affinity Sports, Blue Sombrero and GameChanger, “should enable DKS to better capture data around its core consumer and provide more relevant, targeted offers.” He also said the recent change in its loyalty program that now lets points roll over than expire every December 31 should support traffic.
The analyst also noted that One of DKS’ major vendors “has loosened its MAP policy in recent months but is doing a better job overall of controlling price and distribution. DKS is also excited about the product lineup for this particular vendor.” Earlier this year, Nike moved to allow retailers to advertise 25 percent discounts year round.
Still, Gutman said the first consensus estimates “may be too high” given that many of the investments, including in price, are expected to be weighted toward the first half of the year.
Gutman wrote, “While management anticipates an improvement in 2019, they described recent investments as ongoing and not all of them have been defined. This elevates uncertainty for a business 1) whose EBIT is expected to be down 20% in 2018, 2) operating in a competitive space, and 3) in the early innings of its omni-channel transformation. While we want to believe DKS could be the next BBY or WMT, it seems early.”
Morgan Stanley maintained its estimates, which call for earnings this year of $2.98, down from $3.12 in 2016. The investment firm expects earnings of $2.36 in 2018 and then a slight recovery to $2.49 in 2019.
Photo courtesy Dick’s Sporting Goods
