Academy Sports and Outdoors: A Buy or a Sell?

Until a year ago, investors holding sporting goods retailer Academy Sports and Outdoors’ shares (NASDAQ:ASO) appeared rightfully pleased with their pick, especially comparing it against its main and largest peer Dick’s Sporting Goods (DKS): Academy’s stock almost tripled Dick’s returns.

But YTD, things have reversed and Academy has returned nothing but lackluster performance, with ASO shares down almost 17%, while DKS shares have gained a nice 40%.

If we dig deeper, we see that several reasons lead to this gap. In summary, Academy’s earnings declined and new stores underperformed expectations. Dick’s, on the other hand, after having dealt with some shoplifting issues, has returned on the right trajectory and keeps growing. Academy’s net income is decreasing, while Dick’s has bottomed and seems to be moving slightly up. Free cash flow shows an even wider gap, with Dick’s having quickly recovered from its 2022 lows, while Academy’s FCF is trending downward.

Now, a big part of Academy’s bull-case concerns its expansion plan. The company currently operates in only 18 States and has announced a 5-year expansion plan with the goal of 160-180 new stores, half of which will be in the 18 States, while the other 50% will be in new and adjacent markets.

Clearly, this plan attracts many investors because many believe there is room for the company to grow and take market share from its peers. Moreover, Academy claimed to be able to reach $18M in sales in one year for each newly opened store. However, the company recently had to update its goals, downsizing its 1-year sales target to the $12-$16M range. The main reason for this downward revision lies in the slowing spending in the consumer discretionary sector, which is making Academy’s targets hard to achieve. However, Academy has also discovered that its smaller stores are highly profitable. Therefore, it plans on reducing the capital needed to open a new store by $1M. While this sounds like positive news, it is not enough to offset the minimum expected decrease in sales of $2M.

A third concern, Academy came on strong after the pandemic and in 2021 and 2022 seemed able to consolidate its results. However, the new trend started in 2022 keeps on reverting to the mean, with comparable sales down for the third year in a row now that FY2024 is close to its end. True, Academy’s margins have held stable at over 34%, but its EBIT margin has already deteriorated by 2.4 ppt since 2021.

So, while the company can still show a 5% CAGR in sales from 2019 to 2023, with an 8% yearly growth in gross profit and an EBIT growing 29% per year, we can expect these numbers to come down if Academy doesn’t resume its growth path. Keep in mind that while these financials unfolded, the company continued opening new stores. As a result, a decline in overall sales sounds even more concerning.

Academy’s Q2 Earnings

Academy only opened one new store in Q2 for a total of three new openings in 2024. However, in 2024, it plans on opening 15 to 17 new stores, meaning that we should expect a high number of newly added stores in Q3 and Q4.

I started from this to show how Academy indeed faces some unexpected challenges that are slowing down its growth. In fact, the company wrote in its press release that Q2 sales “were more challenging than expected, impacted by a tough economy”. And yet, Dick’s sales increased 7.8% in Q2 with comparable sales up 4.5%. Academy, on its behalf, reported net sales of $1.5B, down 2.2% YoY, with comparable sales down 6.9% YoY. These results are worse than the one reported in Q1.

Moreover, let’s look at the quarterly income statement to get an idea of what happened.

We see that the cost of goods sold was almost $30M lower YoY, as a result, it had a 63.9% weight on sales vs. 64.4% in Q2 2023. What does this mean? Prices didn’t come down (we are still in an inflationary environment). So, the explanation I have is that customers are trading down and buying cheaper items. When we look at SG&A we then see the bite of inflation with wages increasing and eating away 23.8% of Academy’s sales. As a result, the overall operating income was down $20M YoY. We then see that the company is paying down its debt and has lower interest expenses YoY. This is positive. However, the $2M it saved as interest expense was not enough to offset the impact of lower sales and higher SG&A expenses. The bottom line then shows net income down to $142.6M, a 9.2% decrease. Quarterly EPS was down only 3% because of the positive impact of share repurchases ($220M in the first half). Considering the company can still use almost $500M under its remaining authorization (13% of the current market cap), we can expect the company’s share price to be supported.

This support might be needed and come in handy for Academy’s shareholders because Academy also revised its FY2024 outlook downward. The sales outlook is now lower by almost $300M. Comparable sales are projected to be down between 3 to 6%. Given the result of the first half, I believe we will see Academy wind up at the low end of its updated guidance.

Gross margins should stay stable. But, in a certain way, they show how the company’s scale is not working well. While its store count grows, its scale should help its profitability and increase the contribution margin, if the variable costs per unit remain stable or even decrease thanks to economies of scale. But if the contribution margin doesn’t increase it is because higher fixed costs are offsetting the gains due to softer sales. So, this once again confirms Academy’s poorer than expected performance in new store profitability.

At the same time, capital expenditures should moderate, having a positive impact on FCF, which should not be lower than $290M by the end of the fiscal year. This is a 7.6% FCF yield, which makes the stock rather cheap.

Academy’s Valuation

Academy’s valuation grade is an A, thanks to its fwd PE of 8, its fwd EV/EBITDA just above 6.5 and a fwd P/FCF of 7. Compared to Dick’s, the stock is much cheaper. But this makes sense. After all, Dick’s growth metrics are all positive, while Academy, as we have seen, is facing some hurdles.

A company not growing earnings, can’t trade at a high PE for long. As a result, a mid-single digit PE seems correct to me right now.

Now, I find myself close to selling my position. In fact, Academy is a rare exception in my portfolio, where I usually hold the undisputed leader(s) in a certain niche or market that can generate stable and predictable returns. Academy doesn’t fit under the predictable category anymore due to its wrong expectations on new store financial performance.

Comparable sales are an important KPI and it is not moving in the right direction. This appears even more concerning as its main competitor is reporting a different situation.

In the current environment, expectations for Academy to outperform have moderated. Only the big impact of buybacks will probably protect the stock from a big downfall. But buybacks are only sustainable if profits are.

So, am I selling? Not immediately. This is because of a rule I have, not to react immediately after earnings. I usually take some time after a report to go over it a few times and see if the bull-case has truly deteriorated. After all, Warren Buffett has taught us all that temperament is a key ingredient in investing.

As of now, I am downgrading Academy to a neutral rating and give it a hold. In case I sell out of my position, I will inform my readers right away, either with a pinned comment or a new article.