Sportsman’s Warehouse Properties (NASDAQ:SPWH) announced its second quarter earnings after mine previous writing on the stock, published on July 6 with a hold rating. The company is currently facing significant pressures from macroeconomic as well as climate-related issues, resulting in a deteriorating bottom line. In this update, I look at the company’s strategy critically and update my DCF model based on the latest changes in my views on the company’s finances, as well as the WACC used.
As Sportsman’s Warehouse’s outlook for the rest of the year develops, the stock has fallen almost 20% since the publication of my previous write-up, resulting in a six-month decline of 28%:
Second quarter earnings reported
Sportsman’s Warehouse reported its Q2/FY2024 results on the 6thth of September. The company reported deteriorating earnings that ultimately resulted at significantly worse margins for the company. The company’s same-store sales decreased 16.1% year-over-year, resulting in sales of $309.5 million. Sportsman’s Warehouse’s EBIT also decreased to $0.8 million, compared to last year’s figure of $21.2 million. There should be light at the end of the tunnel, but the end isn’t coming in the next few quarters — the company is guiding for revenue of $310 million to $330 million in the third quarter, compared with last year’s figure of $360 million.
Currently, Sportsman’s Warehouse is focusing on managing the company’s inventory levels along with better cost management. In the company Second quarter earnings call, CEO Joseph Schneider told investors that Sportsman’s Warehouse is planning to reduce inventory with extensive short-term promotions and markdowns to better track current weak sales trends. Inventory management is expected to severely impact Magazina Sportive’s gross margin in the second half of the year, resulting in negative earnings expectations for the third quarter.
Regarding THE cost management, CFO Jeffrey White COMMUNICATE that the company has found about $25 million in annual savings from tight cost management. The company is also focusing on reducing the amount of capital expenditures in the short and medium term by reducing the opening of new Sportsman’s Warehouse stores in the coming years.
A failed strategy?
During the market dynamics heightened by the pandemic, Sportsman’s Warehouse’s strategy was shaped around a large number of new store openings. As I wrote in my previous post, the strategy seems to have failed with investors; currently, the last cover of the Sportsman’s Warehouse rests on the 93 million dollars – The company is burning a significant amount of cash on new store openings, which do not appear to have generated positive returns so far. On the second quarter earnings call, part of the margin decline was attributable to SG&A related to new store openings.
However, new store openings should generate some gains once macroeconomic weakness subsides. In brick-and-mortar stores, it takes customers a little time to find the stores and form the habit of shopping in open stores. In the medium term, the stores could still result in a good amount of cash flow for Sportsman’s Warehouse. For now, however, investors are looking at capex, SG&A growth and bottom line deterioration.
A look into the future
Sportsman’s Warehouse is currently at a very interesting point in time. The company’s management appears to have partially moved on from the previous strategy of opening new stores and is currently focusing on securing operations in the short term through cost cutting. The switch appears to acknowledge the failure of the previous strategy. I believe the new points of focus could put Sportsman’s Warehouse in a better position financially, though – better cost management should be able to create a sustainable addition to the bottom line.
Although the short-term looks lost for the company, I believe that Sportsman’s Warehouse’s medium-term future should still be good relative to expectations. As the macroeconomic situation improves and the poor weather does not disturb Sportsman’s Warehouse sales, the company’s bottom line should in my view recover close to the company’s historical levels. I wouldn’t expect the recovery to be within two quarters, but the company should be in a much better position in a few years. Time will tell how the completed store openings will affect the company’s long-term bottom line.
After my previous DCF model, my views on the company’s financial performance have changed. In the previous model, I estimated that revenues would decline by -3% in FY2024. After a weak second quarter and weak guidance, I have updated my outlook for the year to a -11% decline. As Sportsman’s Warehouse also plans to reduce expansion investments, I also estimate a weaker FY2025 – instead of 11% growth, I estimate 6% growth as a result of normalizing sales levels and some store openings. After FY2025, I estimate that growth will slowly decelerate to a 2.0% permanent growth rate as store openings slow. For FY2033, I estimate revenues of $1,697 million, up from the $1,991 million figure in my previous estimates.
Although Sportsman’s Warehouse guides for very weak margins and currently has very weak margin levels, I believe I underestimated the company’s long-term margins in my previous model. For the current year, I have lowered my expectations from an EBIT margin of 2.5% to a margin of -0.5% due to the reported weakness. After the year, I estimate that the EBIT margin will decrease more than I previously estimated – eventually, I estimate an EBIT margin of 4.6%, instead of a 3.9% margin in my previous model. From FY2012 to FY2019, the company has achieved an average margin of 7.8% – the 4.6% valuation seems fair considering the recent weakness, but the valuation still looks very conservative compared to a long-term average. I still rate the cash flow conversion largely in line with my previous assessment – for some years, the conversion is rated poor due to large capital, but is rated to improve thereafter.
In total, the valuations along with a cost of capital of 10.27% create the following DCF model with a fair value estimate of $6.14, up from the previous estimate of $6.74. However, the fair value estimate is around 34% above the share price at the time of writing:
The weighted average cost of capital used is derived from a capital asset pricing model:
In the second quarter, Sportsman’s Warehouse had about $3.5 million in interest expense. With the current amount of interest-bearing debt of the company, the annual interest rate of the company reaches a figure of 6.46%. I find my previous write-up’s long-term debt-to-equity ratio of 30% reasonable, and I maintain the same assessment in the current model.
On the cost of capital side, I use the 10-year United States bond yield of 4.65% as the risk-free rate. The equity risk premium of 5.91% is by Professor Aswath Damodaran most recent assessment for the United States, made in July. Since my last write-up, there has been a significant change in the beta of Sportsman’s Warehouse – from my previous figure of 1.60, Yahoo Finance estimates that the beta has come down to 0.92. I don’t see the new figure as very representative of Sportsman’s Warehouse’s fair beta – currently lagging earnings lead me to believe the company is far from defensive. In the model, I use the average of the two beta estimates, 1.26. Finally, I add a liquidity premium of 0.5%, compared to a previous figure of 1.0%. I have generally changed my views on the importance of the liquidity premium, leading me to believe that the lower figure is fairer. In total, the assumptions create a cost of capital of 12.60% and a WACC of 10.27%, compared to previous figures of 14.38% and 11.30% respectively.
Although the risk to reward seems to be good at the current price, the investment case does not come without risks. More importantly, I believe that Sportsman’s Warehouse’s future capital expenditures should be closely watched – new store openings have proven detrimental to the company thus far, and I believe that further capital in excess of maintenance goals would indicate a risk-to-reward aggravation. stock – the thesis remains on a safe normalization of the operation of Sportsmen’s Warehouse.
Sportsman’s Warehouse also has a large amount of short term loans with a current amount of 218 million dollars. I believe that taking on further debt would also start to dilute the risk to the stock’s reward – compared to the company’s market capitalization of $167M at the time of writing, the amount is already quite large. I believe Sportsman’s Warehouse can manage the debt though, as management has communicated that it will initiate short-term promotions, which should reduce inventory and create a good amount of short-term cash flow.
Although Sportsman’s Warehouse’s FY2024 looks to be a terrible year, the low share price could mean a good risk to reward stock. As internal as e.g Steven Sansom AND Richard McBee have bought shares in the company recently, some company insiders seem to favor the stock price. My DCF model estimates upside of 34%, making the stock quite intriguing at the current price – unless the store expansion strategy completely fails and the new stores start generating profits at some point, the stock looks set to outperform . . As it stands, I upgrade my rating to a buy rating.