Monday 12 September 2016

Sports Direct International Plc (SPD:LSE)

Sports Direct, a UK based discount sportswear retailer, has had nearly 58% of wiped off its share price in the last year and invites attention. Doubly so, given that it is a business that has long-term viability. Shopping at Sports Direct may not be the best of experiences – its shops are jam packed with stock and a real challenge on one’s patience – but as long as there are bargain hunters looking for their next bargain trainer, there will be Sports Direct. It is a business that is here to stay.

Hence when the market votes so dramatically against Sports Direct, it is worth a look to see if there has been an overreaction to short-term bad news. So the question is – are the shares today a bargain like a Sports Direct clearance where goods go for up to 90% off?

Key Stats







The company had already had a disappointing FY15 – where EBITDA, PBT, and EPS all fell substantially – when it was hit by the twin strikes of Brexit and a major controversy surrounding the company’s employment practices. Brexit will hit the company’s gross margins for sure – it generates ~80% of its revenues in the UK and buys its stock from outside, with a major chunk in USD and the company did not bother to hedge currency risk pre-Brexit. As for its employment practices, the company continues to bear the brunt of negative press to this day; firstly, its CEO Mike Ashley, who holds 55% of the company, got a right royal telling off from the UK’s parliamentary committee, and now institutional shareholders are up in arm’s demanding a full and thorough enquiry and change of ways. The end result is going to be an increase in SG&A as the company mends its way and treats its people more fairly. Both results, hit to gross profit margin and increase in SG&A, don’t augur well for the shareholders and it is only right that the share price fell. The question is, has it fallen by too much, or is it fair?

Using the company’s own prediction for FY17, I get a forecast FY17 P/E of 10.7, and forecast FY17 EV / EBITA of 8.8. This might look cheap, but the company projects a revenue growth of 8% for FY17, a decline in gross margin of not more than 275bps from 44.21%, and an increase in operating costs of not more than 8%. Whilst one could accept the gross margin and operating costs targets, the revenue growth target of 8% looks particularly optimistic given that it suffered a like-for-like fall in sales, and group revenues only increased by 2.5% in FY15. By its own admission, foot fall was low post Brexit.

Adopting management’s forecast numbers, I estimate intrinsic value per share of £3.44 - £3.65, for a return of between 5% and 11%. But if one were to use a 2.5% revenue growth projection - same as was achieved last year - leaving gross margin and operating cost as predicted by management, value per share drops to between £2.18 - £2.51 for a return of between negative 33% and negative 23%. In my opinion, there is more downside potential than upside potential at present - for example the gross margin could fall by much more than the 2.75% projected by management (the company does not disclose details around its purchases) given the fall in Pound and no hedge.

Valuation summary













The market may have voted down Sport Direct for a valid reason. This stock is a wait and watch for now; it may yet become a bargain one day, like a Sports Direct footwear on sale.