A Good Old-Fashioned Growth Stock

David Sterman's picture

Thursday, May 13, 2010 - 2:17pm

by David Sterman

It's not just the birds chirping and the flowers blooming. Even humans are getting in on the spring action; gearing up for softball leagues, mountain hikes and lazy days of fishing. This eternal ritual brings hordes of shoppers to sporting goods stores to check out the latest gear. That helps explain why the parking lots are busy at Big Five Sporting Goods (Nasdaq: BGFV).

Big Five is one of several large publicly-traded sports retailers, along with Dick's Sporting Goods (NYSE: DKS) and Hibbett Sports (Nasdaq: HIBB). But Big Five may have hit on the best approach of the bunch, which should allow ample room for expansion.

Right now, most of the retailer's 384 stores are in the Western United States, half of them in California. The store base grows by about 20 a year. Unlike other sporting goods retailers which re-sell shoes and gear from the brand name manufacturers, Big Five relies more heavily on exclusive products, many of which carry the retailer's brand name. In addition, the company's buyers are always on the lookout for closeout specials, which can yield rock-bottom prices for customers.

This entire approach enables Big Five to be seen as a value-oriented store, so the company maintains very high profit margins. Big Five's gross margins typically fall in the 34% to 35% range -- roughly 500 basis points higher than the rivals' profit margins. And as management keeps a tight lid on store-level expenses, the company generates impressive store-level economics. Stores generate an EBITDA return on invested capital of about 40% in a store's first year, 45% in the second year and nearly 50% in the third year and beyond.

A maturing base of stores has enabled Big Five to steadily expand its footprint by about +5% a year. The rising base of stores yields even greater purchasing power for the company's buyers, which can strike even better deals on closeout sales and private label goods.

The formula worked like a charm -- until the recession hit. Profits slumped badly in 2008, and only partially rebounded in 2009. Prior to the slowdown, Big Five typically earned $1.25 to $1.50 a share each year. As consumers slowly emerge from their shell, profits are likely to stay below the low end of that range this year, but could bounce back toward the $1.40 mark in 2011.

Based on current expansion plans, Big Five is likely to have about 440 stores by the end of 2012. Simply applying historical profit margins on that expanded store base, while allowing for a moderate expansion in corporate overhead, should push 2012 EPS toward the $1.65 mark. This isn't scorching profit growth, but investors are likely to reward Big Five for its slow and steady growth approach.

In its most recent quarter, Big Five noted that stores open more than a year posted a +2.4% jump in same store sales. That's nothing special, but it's all that's really needed for Big Five to pound out its tried-and-true growth formula.

Shares have posted solid gains during the past year and have recently risen to $16, but they have historically traded in the $20 to $30 range prior to the economic downturn. As long as the economy maintains a slow and steady course, shares are likely to work their way back to that range. To get to $25, the midpoint of that range, shares would need to trade for about 18 times 2011 profits, right in-line with the earnings growth rate.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.