Fool contributor Stephen Simpson gave us a snapshot view of the latest financial results for Dick's Sporting Goods (NYSE:DKS). The company managed to increase its top line by 13%, and that combined with improving margins led to growth in operating income of 22% compared with the same period a year ago.
Bodhi Zappa, a die-hard bull, and Hank "The Sky Is Falling" Schofield joined me to share our thoughts about the company's latest conference call. The discussion gives us a better understanding of the condition of the retailer, and how well it is prepared to take on the stiff competition in the quarters ahead. Hank, kick us off.
Hank: Well, the stiff competition that you mentioned is one of the things that I am concerned with in regard to this retailer. Stephen Simpson mentioned a few of its challengers in heavyweight retailers like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT), as well as a giant of the great outdoors in Cabela's (NYSE:CAB). These are the big dogs, but there are a host of smaller stores -- Finish Line (NASDAQ:FINL) and Foot Locker (NYSE:FL) to name just two -- that, like piranhas, have the combined effect of eating away at Dick's business.
Bodhi : Whoa, who's doing the eating? This is why discussions like these are a good thing -- they [separate] the fairy tales from the facts. The reality is Dick's first-quarter results were a knockout, as the company exceeded management expectations for comparable-store sales and earnings per diluted share, which increased 6.5% and 31%, respectively. It achieved "favorable" results across a majority of its product categories, including athletic apparel, baseball, outdoor, as well as outerwear. Because of the great start to fiscal 2006, the company is raising its full-year earnings guidance to a new range of $1.81 to $1.85 per diluted share. It's Dick's who's doing the eating.
Jeremy: Putting the eating metaphor to rest, I have to agree with Bodhi. Dick's is showing every indication that it's prepared to withstand its competitors. When asked to comment on the competitive front, CEO Ed Stack noted that although Bass Pro and Cabela's continue to open up stores, the effect on Dick's has been rather muted as these square footage increases are often limited to one large store, providing little threat to Dick's operations. And aside from what he described as "irrational" pricing behavior from Golf Galaxy, the fear of falling prices and deteriorating margins is unfounded. Dick's appears to have a solid operational foundation in place that will help it increase its stake in this market. Stack suggested as much when asserting that the company's combination of new markets and in-fill stores "will ensure we continue to capture market share."
Bodhi : Confidence, I love it! Beyond filling out its existing territories with additional stores and opening up new markets, this company is growing in an equally important manner: profitability. One of the benefits of being a big dog on the sporting goods block, like Dick's, is that it can use its scale to improve purchasing power. In addition to the positive impact of increased private-label sales, its improved purchasing capability helped it raise gross margins by 90 basis points to 27.5% of sales. The company expects that gross margin improvement to continue into the foreseeable future as it further leverages its size with vendors.
Hank: It should be noted that all is not quiet on the profitability front. While gross margins improved 90 basis points, operating margins gave back some of those gains as sales, general, and administrative (SG&A) expenses took a hit in advertising costs from a lack of overlap with some Galyan's markets. While I'm on the topic of its Galyan's purchase, beyond the merger and relocation costs typically associated with acquisitions like that of a franchise the size of Galyan's, another negative effect of attempting to integrate the territories of both concepts -- Dick's and Galyan's -- is that cannibalization can occur. Comps will continue to be hit by about a percentage point as sales from the respective concepts compete for the same customer base.
Jeremy: Cannibalization concerns are way overblown. There's a McDonald's on seemingly every corner, but the fast-food giant is doing just fine. Sure, some Galyan's stores will steal away a few sales that might otherwise go to Dick's, or vice versa, but this is really a minor quibble when you look at the overall positive impact of having Galyan's on your side rather than competing against you. And in regard to the SG&A hit from a lack of synchronization in advertising, management did add that this increase is only temporary and should be totally normalized by year-end.
Hank: Point taken, but in response to one analyst [who] asked whether the company will then be able to see some leverage on SG&A costs per store, management would not affirm this. Instead, management seemed to sidestep the question, by simply responding that the primary focus is the bottom line.
Foolish bottom line
Jeremy: What's considered sidestepping to Hank is money in the bank for investors. Management will not leverage SG&A expenses at this time as it's able to expand margins through other techniques, like continuing to streamline its inventory management system and leveraging its size for increased purchasing power. And besides, when a company is growing like Dick's currently is, investments in operations like IT upgrades are expected.
Hank, the bear that he is, offered us a couple cautionary notes, but in the end, the story right now is a positive one for Dick's shareholders. If things start to go awry, The Motley Fool will be on top of it. As it stands right now, however, Dick's is expanding in a reasonable manner, making it a worthy addition to any investor's watch list.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.
