Why This Best-in-Class Sports Retailer Looks Like a Bargain

If you don't live in a small or midsize town in the South or Midwest, you may not be familiar with Hibbett Sports (NASDAQ: HIBB  ) . Hibbett is a chain of small sporting goods stores focused on brand-name athletic apparel and team sports equipment. The average store is only 5,000 square feet, but there are already more than 930 locations and plans for the chain to grow to 1,300 over the next five years.

There are several things I like about Hibbett, including its ability to generate healthy cash flow and high returns on capital, management's willingness to repurchase shares, and the company's opportunity to expand its footprint. Additionally, it's trading at P/E and EV/EBITDA multiples below its three- and five-year averages.

Hibbett is very profitable and holds a strong balance sheet and robust free cash flow. The company had a record $65 million in free cash flow in fiscal 2013, but that dropped to just $2 million in 2014. Last year, Hibbett faced extensive capital expenditures in the construction of a new $40 million logistics facility and a new headquarters building, along with opening 72 new stores. Though these projects were a drag on cash flow, Hibbett impressively accomplished all that without acquiring any debt, while still managing to buy back $20 million worth of stock. In 2015, capital expenditures are projected to be cut almost in half and return to a more normal $25 million-$30 million.

When it comes to returns on capital, Hibbett blows away its two biggest public competitors: Dick's Sporting Goods (NYSE: DKS  ) and Big 5 Sporting Goods (NASDAQ: BGFV  ) . The chart below shows the comparisons between return on invested capital. The 10-year average ROIC for Hibbett is above 25% and the five-year average is slightly better. The metrics are just as favorable with return on assets and return on equity.


Source: S&P Capital IQ.

Hibbett isn't run by its founder, but it's about as close as you can come. The chairman and former CEO, Michael Newsome, started with the company as a salesman almost 50 years ago when there were only two stores. The man who succeeded him to the CEO position in 2010, Jeffry Rosenthal, has been with the company since 1998. Both men have been committed to repurchasing Hibbett stock. During their tenures, the company has bought back 12.4 million shares at an average cost basis of $28 per share. Management expects to repurchase an additional 4% of outstanding shares in this fiscal year.

Hibbett is focused on the smaller, less metropolitan markets, a strategy Wal-Mart used successfully when it was starting out. Actually, Hibbett's preferred location is in a strip mall anchored by Wal-Mart. Since Hibbett sells brand-name athletic gear that isn't offered by the world's largest retailer, it benefits from the customer traffic without competing directly.

While we're on the topic of competition, Hibbett goes where its rivals aren't. Only 25% of stores are within a 10-mile range of its competitors. Its small-town emphasis provides the opportunity to offer localized and regional team apparel. This capacity sets Hibbett apart from bigger, national sports gear retailers.


Source: Hibbett Roadshow Presentation.

When a company has industry-leading financial metrics, a strong balance sheet, and opportunity for growth, it usually doesn't come with an inexpensive stock, and that's the case with Hibbett. The stock experienced a sell-off after the company missed analyst expectations on both the top and bottom lines in the fourth quarter of last year. Same-store sales growth was an anemic 1.8%, down from the previous year's 6% comp. Then, last quarter, Hibbett exceeded earnings expectations but didn't meet the revenue consensus, causing more investors to cash in their chips.

Situations such as this offer the business-minded investor the opportunity to purchase a well-run company at a discount to its historic valuation. I believe many Hibbett investors have been shortsighted, selling at the first hint of what they perceive to be trouble. I attribute much of the stock decline to recency bias -- the tendency of people to overweight the most recent information. This is despite the fact that there are plenty of things to like about the company, and management has expressed optimism about the second quarter.

In late December, Hibbett's share price peaked just below $68. The stock is now trading below 19 times earnings and only a few dollars above its 52-week low of $50. This represents a drop of 23% at current prices from it's former high. The company's three- and five-year quarterly average P/E is just shy of 22. According to S&P Capital IQ, it hasn't been this low on an average quarterly basis since 2010. However, there have certainly been times since then, particularly in 2011 and late last year, when it traded at or below the current multiple. This same relative valuation holds true on an enterprise value-to-EBITDA ratio.  

Viewed against the rest of the industry, Hibbett looks expensive. Dick's and Big Five sport P/E multiples of 16 and 11, respectively. With Hibbett's earnings multiple of 19, you may be tempted by its peers' lower perceived price. What you would be missing is the outstanding returns on capital and the demonstrated opportunity for growth, buoyed by high free cash flow.  

Despite the discounted valuation, Hibbett's margins are better than average and have mostly been improving. The market also seems to be discounting that management is working on plans for a digital commerce platform. Once this takes effect, new opportunities should open up outside of the small-town markets.


Source: S&P Capital IQ.

One of Warren Buffett's many wise sayings is that it's better to buy a great business at a fair price than a fair business at a great price. Hibbett might not be a screaming buy at current levels, but it is certainly available at a fair price, and maybe a little bit better. An investor could certainly do worse than to hold this cash-generating business with little competition in its niche market while it continues to expand over the next several years.

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