Why These Sporting Goods Retailers Are Losing Out to the Competition

Vestis Retail Group, the company known for its Eastern Mountain Sports, Bob's Stores, and Sport Chalet chains, filed for bankruptcy earlier this week. However, this was just the latest in a string of similar announcements in this space. In March, Sports Authority announced the closure of about 140 of its 460 stores as part of its own bankruptcy proceedings after the company missed a crucial interest payment earlier this year.

In this episode of Industry Focus: Consumer Goods, Sean O'Reilly and Vincent Shen break down the winners and losers among sporting goods retailers and the challenges these companies face with the rise of e-commerce and other major headwinds. Also, the team shares an update on the divestitures at Anheuser-Busch InBev (BUD 0.39%) as the company seeks regulatory approval for its $108 billion acquisition of SABMiller (NASDAQOTH: SBMRY).

A full transcript follows the video.

This podcast was recorded on April 19, 2016. 

Sean O'Reilly: Sporting goods retailers are struggling. Are kids not playing sports anymore? On this consumer goods edition of Industry Focus.

Greetings, Fools! Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is April 19th, 2016, and joining me in studio is the Fool's own resident polymath, Mr. Vincent Shen. What's up, Vince? I missed you.

Vincent Shen: Polymath, I like that, that's a good one. I'm doing well

O'Reilly: Yeah. I've seen your presentation skills... you're good.

Shen: How was your trip home? 

O'Reilly: It was awesome. I went to the Buckeye state, and it was 70 and sunny every single day. The week previously, actually, the running joke with my family was, we would go to a Target or a Sam's Club, and there'd still be a pile of snow in the parking lot.

Shen: Oh, really?

O'Reilly: They were small piles, granted. But it's absurd.

Shen: Probably gone now, after the weather we've had, even around here, lately.

O'Reilly: But proof positive that jokes about Ohio's weather are there for a reason. (laughs) So before we dive in to talk about struggling sports retailers, which we haven't touched on a ton in the past, but it's a super interesting subject -- I wanted to dive into following up on a story we covered a while ago, which was AB InBev's proposed acquisition of SABMiller.

Shen: Huge deal -- over $100 billion.

O'Reilly: You sent this to me this morning -- very interesting article in The Wall Street Journal. They accepted a bid, I guess, of $2.9 billion in cash from Japan's Asahi Group for SABMiller's premium beer brands -- and these are the European brands -- Peroni, Grolsch -- I am totally butchering that, if anybody wants to correct me ... I took French in high school. Anyway. Also, British beer Meantime. One, that's a nice chunk of change. Two, and what I wanted to highlight, this was just one of many divestitures these companies are doing in order to get this deal done.

Shen: When the deal was first announced, we were breaking that down. We always caveat some of these bigger M&A deals that they sign that there is going to be some stipulations in there, there's going to be some things they need to do in order to help increase their odds of regulatory approval. In this case, obviously, some of those divestitures, this being one of them, I think they received the offer from Asahi in February or March. And now it's been finalized. So you mentioned, Japan is eager to expand and get their hands on...

O'Reilly: This is their first big acquisition outside of Japan.

Shen: In some time, yeah. Previously, I think they had a pretty big deal, about $13-$14 billion...

O'Reilly: Oh, that's right, they bought Jim Beam.

Shen: Jim Beam, Maker's Mark. So as you mentioned, this is one of many. What were some of the other divestitures?

O'Reilly: The first thing to go, and this was, like, a given, totally going to happen, was SABMiller's 48%, I think, interest in MillerCoors LLC, which was their joint distribution center with Molson Coors Brewing.

Shen: Of course.

O'Reilly: Ironically enough, they created that joint venture in order to compete more effectively with Budweiser's distribution. Irony is the spice of life, I guess. But that definitely happened already. In March, the company agreed to sell SABMiller's Chinese beer business to China Resources Beer Holdings -- boy, they really got creative with that name. That was done in order to gain antitrust approval from the government of the People's Republic of China. Even after all these divestitures, and all of this definitely need to happen in order to close the deal -- the combined entity's going to have 30% global market share of the beer industry on this planet. They're going to have 90% market share -- and I saw this list, they are 190 countries on this planet, they're going to have 90% market share in a couple of dozen Latin American and African countries.

Shen: Wow.

O'Reilly: So these definitely need to happen. And that's really why they're doing it. They want to match up the South American and African beer distribution and markets, because those are center, where you're going to see a lot of growth, and GDP growth, and everything. This is definitely a long game.

Shen: It's interesting, too -- we talk about the deal itself, over $100 billion. Some of these divestitures are not small by any stretch.

O'Reilly: This is a $3 billion deal right here, and it's just a line item!

Shen: You have the Asahi deal, $3 billion, not small by any stretch. And also, the MillerCoors joint venture you mentioned -- that was sold to Molson Coors for $12 billion. And I did not know this until we started doing some of the research originally, learning about CR Snow, that's the No. 1 selling beer by volume in the world. Obviously, driven a lot by its popularity in the Chinese market, huge market. But that deal was, considering how powerful that is, the No. 1 selling beer brand by volume, and that deal was only $1.6 billion. So that was generally seen as a very good deal for China Resources. But again...

O'Reilly: We should go get some Snow. Have you had it?

Shen: I've never had it; I would like to.

O'Reilly: You really need to, yeah.

Shen: Hopefully, we can find it at a store around here.

O'Reilly: For sure. But bottom line... this is happening. And I do think the deal will eventually go through. Actually, I kind of like it, because they're positioning themselves for another century of growth in all these high-growth markets.

Anyway...before we dive into the world of sports retailing, I wanted to point any listeners out there who are hungry for more Foolish content to head over to focus.fool.com, where all Industry Focus listeners have access to a special discount on the Motley Fool's Stock Advisor newsletter. The discount works out to $129 for a full two-year subscription. Once again, that is focus.fool.com. Vince, I guess the cat's out of the bag -- Industry Focus is now on Spotify.

Shen: Yes. I'm glad that you mentioned that. I definitely wanted to bring that up during the show today, at least, so our listeners know, because I had not realized until we were talking about this partnership, where Spotify was moving into podcasts. So it's awesome to be on there.

O'Reilly: We should play that song, "Moving On Up," or something. 

Shen: (laughs) 

O'Reilly: So Vince, digging in here to the world of sports retailing. We're touching on a subject I kind of noticed, just observing the retail world in the last 10 years. Sports retailers are not doing so hot.

Shen: Obviously, this is one niche of the broader retail space, especially if you're thinking leisure, with leisure wear, which is a big part of these businesses. But I just thought it was interesting, because it kind of reflects a lot of the challenges that a lot of retailers are having now. So we've heard a little bit about these struggling brands, and probably a lot of us are familiar with them. Think, for a second, about Sports Authority. It was previously the largest sports-equipment chain. The product of many, many acquisitions. It was taken private in a leveraged buyout deal. But they filed for bankruptcy protection in March. They're closing about 140 of their 460 locations. And their current owner is private equity firm Leonard Green & Partners. So they bought,,,

O'Reilly: ...they bought the thing in bankruptcy?

Shen: No, that's currently. They purchased Sports Authority for about $1.3 billion in 2006. Over time, they've accumulated about $1.1 billion of debt, usually a pretty common characteristic of these LBOs, and the company has struggled to operate under that kind of debt pressure. So in January, they missed an interest payment. And since then, they've been pretty actively looking for, essentially, a white-knight buyer to come in and save the company. And though management mentioned they've received a lot of high interest from buyers, nothing really came together. So they're in bankruptcy protection now.

Interestingly, for fiscal 2015 that ended January 30th, 2016, the company had revenue of about $2.6 billion, so still a pretty big business. Like I said, 460 locations. But it had before-tax losses of $156 million, according to the Wall Street Journal. And there's going to be a two-part auction. On May 4th, they have leases for over 100 of their closing stores going up for sale, and the remainder of the assets -- so pretty much everything -- potentially go up for bidding about two weeks later on May 16th. There's been interest, obviously, from other competitors who are still going. So think privately held Academy Sports + Outdoors, Dick's Sporting Goods (DKS -0.89%), Modell's, which is family owned, have all talked about getting involved in the bidding process. 

So on the one hand, you have competitors who might purchase assets and keep stores open as a going concern. On the other hand, you have liquidation firms that might outbid them, and just buy it out and liquidate all the assets. So it'll be interesting to see what's left of Sports Authority. It's still a big brand, I'd be surprised to see every single store close.

O'Reilly: Yeah, it's wild. What's the deal with City Sports?

Shen: City Sports is a smaller example. That actually happened about last October. They're based out of Boston. Again, just another example -- smaller chain, filed for bankruptcy last year. They closed eight of their 26 locations, and investors ended up buying some of their intellectual property. So they're hoping to revive that chain. But in very recent news -- this just happened yesterday -- we have Vestis Retail Group. So again, yet another example of the dominoes falling at this point for this industry. They operate a lot of big chains most people will be familiar with -- Eastern Mountain Sports, Bob's Stores, Sports Chalet, which is out on the West Coast. They are run by Versa Capital Management, a private equity firm. They acquired each of these chains separately, and essentially put them under a single umbrella. So they specialize in turning around some of these distressed businesses.

So Vestis was formed in 2012, after buying out Eastern Mountain Sports and Bob's. They added Sports Chalet in 2014. But the thing is, Sports Chalet was already struggling significantly. They'd been in business for over half a century at this point, but they'd been scarred by a lot of losses, declining results in the last 12 months. They were public, and in their last 12 months as a public company, reported $343 million in revenue. Bottom line lost $9 million, or $0.64 per share. Another big thing you'll notice -- their gross margins, for example, declined from about 30.5% in fiscal 2010 and 2011 to 26.7% by the time the company was acquired.

O'Reilly: And that, of course, implies they're having to cut prices in order to move products, which is never good.

Shen: Obviously, they were struggling with their operations. So Sports Chalet is done. Versa's hoping to maintain Bob's Stores and Eastern Mountain Sports. But Vestis CEO Mark Walsh -- and I wanted to mention this specifically -- cited online competition and warm winter weather as some of the drivers for the tough times that the different store...

O'Reilly: I don't buy that winter weather thing. (laughs) 

Shen: That's a one-time thing. Going bigger picture, those are just some of the examples of the brands or chains that have fallen victim to this very-competitive environment. But let's look at each of these potential drivers. The short term on that you just mentioned -- you're a little bit skeptical about -- is the warmer weather from this winter season. Obviously, it's more of a one-time hit. 

O'Reilly: It might have been the straw that broke the camel's back.

Shen: Exactly. And the thing is, it was not a small headwind by any stretch. The management for Dick's Sporting Goods mentioned that cold-weather-related categories were down double digits this past winter.

O'Reilly: That's not great, yeah.

Shen: So that's not going to help a company that's already struggling. So moving on to a bigger picture, longer-term trend. A lot of people will want to just point to an Amazon.com as a reason why these companies have been struggling. We know that e-commerce and online retailers have made it tougher, and forced a lot of retailers to adapt. I think that's a pretty obvious connection. But at the same time, if you think about the sporting goods, in general, that these companies are involved in, the Internet has really changed how people shop for specialty items. If you think about how, just in the past 30 years ago, you might go to one of these stores. and the sales associates would be specialists. And they'd be the ones recommending to you, "Oh, your son should get this baseball glove." Or, "Your daughter should get this pair of soccer cleats, it's really popular this season." And they were the experts. But now, everything is online. Think Amazon reviews, or just...

O'Reilly: This baseball glove got five stars. (laughs) 

Shen: Just think about all the different reviews on YouTube, on different message boards, blogs around these different sports and hobbies. And those are the places you're getting a lot of expertise now. It's changed. Thirty years ago, you'd go to a sales associate for that kind of expertise. Now, if you go to a Sports Authority, the only thing they might do for you is check if there's stock in the back. So it's an interesting change in the dynamic.

Another thing is increased competition from other retailers, and the suppliers themselves. So for a company like this, Sports Authority or City Sports, Nike, for example, might be a huge supplier in terms of retail and other equipment. And they have really important relationships with these brick-and-mortar operations. But Nike's expanded itself into direct-to-consumer sales. That's a big growth point for them. So Nike, as a single example, is generating 23% of their sales now from direct-to-consumer in fiscal 2015. That's about $6.6 billion. And that's up 25% over the previous year, and that's up from just $2.2 billion, or 13% of sales in 2009. So in that five-to-six year time span, they have tripled that number. And that's money that's coming out of the pockets of these brick-and-mortar retailers. Under Armour, as another example, is doing well above 30% of their sales direct to consumer. So here's another example on even their own suppliers making the situation a little harder for them to compete in.

And then, one of the last things I want to talk about -- you have specialization. If you have these different niches within sporting goods, you know, athleisure wear, you might have premium wear, like Lululemon. But if you want just something that's basic, cheaper, and you're on more of a budget, you might just go to a Wal-Mart or a Target for what you need. So the environment for the retailers in this space is really difficult.

So talking about some of the companies that have struggled, why they've struggled, I also wanted to talk about Dick's Sporting Goods, because they're the big dog now. They were previously second to Sports Authority, but they're actually the largest sports specialty retailer in the space now. They have $7.3 billion in revenue for the most-recent fiscal year, and that gives it about 10%-15% market share for this market. National Sporting Goods Association puts this total market at about $64 billion annually. And recently, the company presented at the Bank of America Merrill Lynch Consumer Retailer Conference in March. And during the presentation, funnily enough, one of the very first slides is titled, "Power of Omni-channel." Not surprising at all.

O'Reilly: It's like they stole the slide from Macy's or something. (laughs) 

Shen: Keep in mind, the company has had about 39% compound annual growth from 2010 to 2015 for their e-commerce sales.

O'Reilly: So people are going to dickssportinggoods.com, and ordering a baseball bat on there.

Shen: So some of the things they're doing well -- in 2010, they had $140 million in online sales, about 3% of their top line. By 2015, it's $748 million, over 10% of their top line. So obviously, there's that shift in the pie. But also, it's interesting, because, he talks about the physical footprint of Dick's Sporting Goods still being a really important piece of their omni-channel strategy. And he says that if they enter a new market or under-served market, a new store opening will usually double e-commerce sales in that region for them. I guess the main thing they offer now -- before, it may have been expertise, which, some companies still do. For an outdoor-goods retailer, REI is really well known, and they've been able to carve out a niche, for customer service, for a lot of the sales associates still having expertise.

O'Reilly: And refusing to open on Black Friday, yeah. (laughs) 

Shen: Little things like that. But in a case like Dick's, where a lot of it's commoditized, it's like, "We want to make sure the consumer can get whatever they want, however they want it, be it picking up in store, ordering online, going to the store and ordering through the store if the stock's not there, and having everything they need lined up to fulfill what the customer wants."

O'Reilly: It definitely seems to me that the industry at large that we're talking about was just a case of, there were too many players, and somebody had to go. And the winner, obviously, in this situation, for not the high-end stuff but just the guy who needs a baseball glove for his kid, is Dick's. They're clearly the winner. Out West, you have the Big 5 Sporting Goods and all that stuff.

Shen: Which appeals also to the discount market, as well.

O'Reilly: For sure.

Shen: So like I said, they've kind of carved out their niche. Dick's is playing this broader strategy, but they're doing it in a really interesting way. While these other stores are closing a lot of locations, Dick's has been expanding a lot. They opened, I think 200 locations in the past few years, and I think part of that is expanding that footprint, and the fact that it's helpful for them with shipping to store, and using these locations.

O'Reilly: Did you happen to hear what they did with Sears?

Shen: No I didn't.

O'Reilly: I think it was at a Sears location. This was like cobwebs old.

Shen: I think it was in King of Prussia?

O'Reilly: Yeah, King of Prussia Mall. Sears, I guess, partitioned off the second level of a location there, and then they sold a portion of it to Dick's in a long-term lease, or whatever. And that's obviously part of Sears' plans to unlock the value of the real estate. But yeah, it was just interesting to see what they'll do with that, if that's a possibility, because then, all the sudden, it's like a distribution front retail thing for omni-channel. So really quick, what did you think of Dick's Sporting Goods' valuation right now? It's at $47, trailing earnings of 280. Does that interest you at all?

Shen: The thing is, it's surprising to me, after reading enough about it, and doing enough research on the industry, you would think the growth opportunity is not that great. But like I said, they've opened 200 new locations over the past few years. Their current footprint is about 650 stores. Management sees the overall long-term potential at about 1,100 locations. The thing is, if you compare them to other big-box retailers, so to speak, like a Best Buy, they are on the smaller end in terms of number of locations. So they do have that runway. And they are really focused on, I think it was like e-commerce, driving productivity in those stores. They're bringing their e-commerce operation, for example, in house to have better control over it, and to generate some savings there. Overall, a really interesting business.

O'Reilly: Yeah, it definitely seems like they're the current winner.

Shen: The thing is, you either look at it that way, or you look at, maybe not smaller operations -- the stores definitely are smaller -- but you have a specialized company like Lululemon, or you have a company like REI or Cabela's, where it's going to be focused more on the outdoors, hunting, firearms. Being able to carve out that niche and present that value to the shopper is really important. Otherwise, this is just a very intensely competitive space right now.

O'Reilly: Cool. Thanks for your thoughts, Vince. Have a good one.

Shen: Thanks Sean, I appreciate it.

O'Reilly: If you're a loyal listener and have questions or comments, we would love to hear from you, just email us at [email protected]. Once again, that's [email protected]. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Vincent Shen, I'm Sean O'Reilly. Thanks for listening and Fool on!