Why Academy Sports And Outdoors May Report Its Highest Q4 Ever (NASDAQ:ASO)

Introduction

Academy Sports and Outdoors’ (NASDAQ:ASO) Q4 and FY2023 earnings are coming and there are reasons to believe the retailer will beat estimates. With so much talk about inflation and high interest rates, everyone was expecting extended consumer spending weakness. Furthermore, increasing shrink seemed to confirm an overall distress in many areas across the country. As a result, retailers saw some downward pressure, with DICK’S Sporting Goods (DKS) losing 25% of its market cap in one day, bottoming at a share price just above $100. Since then, DICK’S stock has doubled. But up until the beginning of February, DICK’S was trading at par with Academy. It was mainly after its recent earnings report that the stock soared, leading to a big jump in gains.

I actually expect Academy to show similar behavior, and in this article, I will explain why I think so.

Summary of previous coverage

Among the main reasons I’m long Academy, there are two I highlighted in my past article, which I now want to recall:

1. Against its competitors, Academy has more geographical room to grow in the U.S. because its footprint covers mainly those states in the South and the East of the country.
2. The pandemic created a new tailwind for its sales, but Academy has shown it has been able to rebase its business metrics (top and bottom line) and consolidate the business into renewed and enhanced profitability.

Its store expansion plan is convincing, and I’m expecting it will drive sales up to almost $10 billion by 2027, with at least a 16% EBITDA margin. This gave the result the company was trading around a fwd 2027 EV/EBITDA multiple of 3.5 while the stock price of $47. Thus, my fair value came in around $65. But recent favorable developments for retailers driven by stronger-than-expected consumer spending, leads me now to revise upwards my estimate.

Positive News From DICK’S

Academy usually reports earnings after its main competitor DICK’S. Therefore, though the latter has a different size and footprint from Academy, as we can see from the map below, we can still feel the pulse of the industry and modify our expectations for Academy accordingly.

However, this is not a simple linear equation to be solved. In fact, given Academy’s footprint, we know the company operates in some of the wealthiest states in the country and thus has customers from households whose income is between $30k and $140k. Moreover, Academy’s profitability metrics currently lead the industry, with the highest sales per square foot result, the highest sales per store and EBITDA per store, and the best operating cash flow as a percentage of sales.

DICK’S shares rallied after Q4 earnings because, in its press release, it reported quarterly comparable sales growth of 2.8% (2.4% for the full year). But, even more importantly, DICK’S reported EPS growth above 14%, confirming its gross margin has re-baselined well above 2019 levels. According to the 2024 guidance, DICK’S expects comparable sales growth of 1%-2%.

DICK’S management, however, reported the issue of shrink (i.e. theft) to be still ongoing and hitting merchandise margin. On the other hand, we have seen Academy a bit more insulated from this issue, due to its different demographics.

A positive news from DICK’S was that its inventory level increased only 1%, meaning the company is actually managing its stocks well and it can sell its merchandise at a decent pace.

As a result, investors confirmed their renewed enthusiasm for the stock, pushing it at its all-time highs, well above $200 a share.

Now, before we move on, let’s look at DICK’S earnings surprise track record. In the past 12 quarters, it always beat consensus, apart from Q2 2023.

Let’s compare this with Academy’s track record:

Academy missed estimates twice in the past three quarters. On the other hand, when it beats estimates, it usually does so by a higher margin than DICK’S.

Since Q4 consumer spending has been strong and since DICK’S reported a big and unexpected beat, things are poised for Academy to over-deliver.

Academy Q4 Earnings Preview

So, let’s look at a few numbers and make an educated guess about the earnings Academy is about to report.

ASO is expected to post Q4 EPS of $2.29, which would equal to a year-over-year growth of 12.4%. DICK’S, on the other hand, was already expected to report a 14% growth YoY. Well, as we said, its results came another 14% above this forecast. We have a wide fork between what the market expects from Academy and what DICK’S delivered. I’m inclined to think this gap between the two results will narrow, since no particular signs are showing that DICK’S execution is crushing Academy’s to the extent it can deliver such unexpected results.

Revenue estimates see Academy report a 2.55% growth to $1.8 billion.

I think analysts are being too conservative, and I expect Academy to report its highest Q4 ever, with a YoY revenue growth above 7%. This leads me to expect a Q4 revenue of $1.89* billion. Margins should be slightly improving, though a little bit of shrinkage and wage hikes may almost completely offset the benefit from cooling inflation and lower transportation and logistics costs. As a result, I expect an EBITDA margin of 13% and a net income margin of 9%. This should lead Academy to report $170 million in net income. Dividing it by the number of shares outstanding – 74 million – we have a Q4 EPS estimate of $2.29.

However, at the end of Q3, the company still had around $100 million available on its share repurchase authorization, in addition to the new $600 million share repurchase authorization. This is $700 million available for the next three years. I expect the company to have returned another $40 million to its shareholders via buybacks. During Q4, Academy’s stock price moved from the low $40s to the mid $60s. Let’s assume the average purchasing price was then $54. This means the company bought back 740k shares.

Let’s assume the average purchasing price was then $54. This means the company bought back 740k shares. This could make Academy’s EPS go up to $2.32, which is 1.3% above the current consensus. I set this as the minimum threshold to consider Academy’s upcoming report good.

If Academy delivers according to my estimate, it will report FY2023 EPS of $7.06, which means the stock is trading at a 10 PE. DICK’S currently trades around a 16 PE, and this makes Academy highly undervalued to its closes and less profitable peer.

But let’s focus on the most important metric: Free cash flow. After all, investing is about the free cash flow a business is expected to generate.

Currently, DICK’S trades at a FCF yield below 4%, while Academy sports a 7.3% FCF yield. True, Academy is spending more on capex because it’s currently expanding and building new stores at a faster pace than DICK’S. As a result, investors should be aware of the undergoing investment cycle. This explains why the yield is higher: Investors are discounting some unpredictability of future free cash flows. Yet, if Academy’s investment leads to the returns the company expects (20%), the current FCF yield is still a compelling opportunity.

Under this perspective, if Academy were to trade at the same FCF yield as DICK’S, the stock price should be worth around $118 a share.

Let’s bake in a discount due to Academy’s investment cycle, but let’s lower the yield to 6%. The fair value would be around $80. This is why I have come to revise upwards my fair value estimate and rate Academy once again as a buy.