Has This Series of Events Created the Perfect Value Investment?

Big 5 Sporting Goods (NASDAQ: BGFV  ) experienced the perfect combination of events to trade significantly lower, but sometimes those events can also create value.

What started it?
It all started in late July:  Big 5 had trended to 52-week highs after a one-year 200% plus gain. Then the company announced earnings, and its stock fell by more than 15%.

In that loss-provoking quarter, Big 5 not only increased its same-store sales by 4.4% year over year but saw net income growth of 135% during the same period. Thus, margins significantly rose.

Therefore, Big 5 had a good quarter, but unfortunately its 6% total revenue growth was not enough to satisfy Wall Street. Hence, investors apparently overlooked the company's margin improvement and its increase in store traffic to instead focus on a $3.57 million miss on the top line.

The events that followed
I suppose Big 5's quarter could be called mixed, but still not bad enough to create its 32% loss since announcing earnings in late July. In many ways, it seemed logical for Big 5 to begin its post-earnings rally after its fall, but the company continued to have a series of weights that pulled it lower -- two being peers Dick's Sporting Goods (NYSE: DKS  ) and Hibbett Sports (NASDAQ: HIBB  ) .

Dick's reported earnings on Aug. 20 – about three weeks after Big 5 – and was also short of estimates. In Dick's quarter, same-store sales rose just 1.2% -- far short of Big 5's 4.4% rise -- compared to guidance for a 3.5%-4.5% rise. As a result, Dick's revised its guidance downward and its stock fell more than 5%, thus weighing on Big 5.

Then, three days later, Hibbett Sports announced a mixed report, being short on revenue estimates and revising full-year earnings-per-share estimates below the consensus. Moreover, comparable-store sales for the sports retailer rose just 0.3%, also significantly lower than Big 5.

A difference in performance
So, if we look at all three stocks since July 26, we already know that Big 5 has lost 32% of its value, but Hibbett has only lost 2% and Dick's has surprisingly gained 3% during the period. Perhaps announcing earnings first did not favor Big 5, and then being dragged lower from the weakness of its peers made the performance that much worse.

Finally, Big 5 received a downgrade to Neutral from Buy by one of the few analysts that cover the stock, but still it doesn't make sense that Big 5 would lose so much value relative to its peers.

Valuation must be the cause?
Like I said, we already know that Big 5's comparable sales, revenue, and margin expansion were far greater than those of its competitors. We also know that Big 5's stock performance has been far worse than its competitors. Therefore, the only way to logically explain Big 5's performance is to assume that it's due to valuation, and that both Hibbett and Dick's are cheaper stocks, right? Well, let's take a look at a few key metrics for each of the three companies based on trailing-12 months of fundamentals.

 

Big 5 

Hibbett 

Dick's 

Trailing P/E

14.27

19.46

20.28

Forward P/E

11.30

17.61

17

Price/Sales

0.38

1.72

1.12

Price/Operating Cash-Flow

8.40

19.38

17.6

Operating Margins

4.45%

14.25%

8.96%

Surprisingly, Big 5 is not only the cheapest of these three companies, but it is far cheaper. In fact, there's not even a remote comparison.

Big 5 trades at 0.4 times sales; that's about one-third of Dick's! Big 5 has a forward P/E ratio of 11.3, about 50% cheaper than either competitor, and both Hibbett and Dick's are more than twice as expensive compared to operating cash flow.

Hence, it makes absolutely zero sense that Big 5 is trading lower while its competitors are not. Moreover, the number that really jumps off the page to me is Big 5's operating margin compared to the others.

With a 4.4% operating margin and all three operating in the same space, there is a great deal of room for Big 5 to improve its margin. In theory, with all three companies operating in the same space, and many of the basic or essential costs being the same, there is no reason that we can't use Dick's and Hibbett's margins as a guide to what Big 5 could achieve if operating to perfection. Perhaps, this "room" is why Big 5 has seen its operating margin rise from 2.1%, to 2.7% and 4.4% in years 2011, 2012, and over the last 12 months. 

With Hibbett having margins greater than 14%, Big 5 investors should be encouraged. Meanwhile, Dick's and Hibbett investors should be wondering if either company has room to improve.

Final thoughts
Overall, Big 5 is presenting what value investors like to see. It is significantly outperforming its industry with fundamentals, but is also much cheaper.

Clearly, a combination of being the first company to report earnings, and then feeling the effect of two dismal earning reports in the weeks that followed, took a toll on Big 5.

With that said, Big 5 has apparently found a level trading range, trading flat in the month of September. With the amount of value that's present, this flat trading might be an indication that it's time to take advantage of this value investment.

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