Every once in a while, a company comes along and really wows me. That was the case recently when I began kicking the tires on Dick's Sporting Goods (NYSE:DKS). Say what you want about retailers being "bad businesses" -- but when a retail concept works, it can really work (think Wal-Mart (NYSE:WMT), Home Depot (NYSE:HD), and Best Buy (NYSE:BBY)).
Today and next week, I want to share with you eight factors that I believe could make Dick's one of those rare retail concepts that is capable of sustained, competitor-busting growth -- the type of growth that can create a ton of shareholder value over time.
1. Differentiation in a highly fragmented sector
When you think of discount retailers, probably only a few names come to mind: Wal-Mart and Target (NYSE:TGT), most likely. Same with consumer electronics: Best Buy and Circuit City (NYSE:CC). But when you think of sporting goods, there's probably no one or two companies that dominate your mindshare. Depending on what part of the country you live in, you might think of any number of outlets, including Sports Authority (NYSE:TSA), Dick's, Gart Sports (NASDAQ:GRTS), Big Five (NASDAQ:BGFV), or Galyan's (NASDAQ:GLYN) -- which, by the way, are the five largest sporting goods retailers, respectively, as measured by sales.
This is all to say that compared to other sectors, sporting goods is relatively fragmented. Whereas the top five discount stores have an estimated 75%-plus market share, the top five sporting goods retailers occupy only 11% of their market. The fragmented nature of this market creates the potential for a dominant sporting goods concept to rise up and capture a much larger share of the overall pie. And that's precisely what I believe Dick's is capable of -- thanks to its innovative store format and unique merchandising philosophy.
Dick's is a full-line sporting goods retailer offering a broad range of name-brand sports apparel, footwear, and equipment. Like Sports Authority, Dick's store format follows the "big box" model, meaning either anchor stores in strip malls or large free-standing locations. But unlike Sports Authority, which some have described as feeling like a grocery store, Dick's features a "store-within-a-store" format that offers the convenience of five specialty stores under one roof (explained as follows in Dick's 10-K):
- Pro Shop -- a golf shop with a putting green and hitting area and video monitors featuring golf tournaments and instruction on the Golf Channel or other sources.
- Footwear Center -- featuring hardwood floors, a track for testing athletic shoes or in-line skates, and a bank of video monitors playing sporting events.
- Cycle Shop -- designed to sell and service bikes, complete with a mechanics' work area and equipment on the sales floor.
- Sportsman's Lodge -- for the hunting and fishing customer, designed to have the look of an authentic bait and tackle shop.
- Total Sports -- a seasonal sports area displaying sports equipment and athletic apparel associated with specific seasonal sports, such as hockey and baseball.
Rounding out the customer experience is Dick's commitment to superior customer service, particularly in the arena of staff expertise. Dick's actively recruits sports enthusiasts to staff its stores, living up to its slogan, "We love sports as much as you do." This means PGA pros in the Pro Shop and bike mechanics in the Cycle Shop. These enthusiast-level staffers have the knowledge and personal experience necessary to demonstrate and explain product advantages to customers, thus leading to higher sales.
In sum, the shopping experience at Dick's is in a league of its own.
2. Quasi-aspirational brand
Dick's isn't aspirational in the way that Tiffany (NYSE:TIF) is among jewlrey retailers, but Dick's is certainly a cut above your average sporting goods outlet. Dick's stated target customer is "the authentic athlete and outdoor enthusiast." That's not to say Dick's only caters to the premium sports segment; no, they carry a full-line of merchandise, ranging from beginner to intermediate to enthusiast levels. But what differentiates Dick's is that if you're the type of person who is inspired by the best, the newest, the most state-of-the-art sporting gear, Dick's does in fact offer it.
For the sports enthusiast, this makes Dick's the legitimate place to shop. And for the rest of us -- the wannabe-like-Mike type of people -- shopping at Dick's makes us at least feel like serious athletes. So even if you're actually Joe Occasional Jogger, buying your sneakers at Dick's reminds you of your dream to someday run a marathon.
3. Not the biggest, but the most profitable
As I mentioned earlier, by sales, Dick's is the #2 sporting goods retailer, behind Sports Authority. But by profits, Dick's is the hands-down leader. Last year marked the fifth straight year in which Dick's led its sector in profits (as measured by income from continuing operations and adjusted for competitors' one-time items). In 2002, it wasn't even close -- Dick's outpaced the nearest competitor (Gart Sports) by 65%. Here's how the profit race fared among the sector's top five in 2002:
Net Net($ millions)IncomeSalesMarginDick's $38.3 $1,272.6 3.0%Gart Sports 23.2 1,051.2 2.2%Big 5 21.8 667.5 3.3%Galyan's 18.7 597.8 3.1%Sports Authority 14.1 1,426.9 1.0%
4. Management focused on capital efficient growth.
So often with retailers, I find management teams that are focused on nothing but growth, growth, growth. These are the retailers that invariably have spiraling debt and sloppy inventory management. (As a side note, such retailers can be great short candidates.) That's why my eyes nearly popped out of my head when I read the following in Dick's year-end 2002 earnings press release: "Return on invested capital, inventory turns, and margin rates are the three key metrics we continue to focus on."
That's music to my ears, especially in the context of Dick's parallel focus on growth. Dick's grew sales by 18% in 2002 -- faster than all of its competitors with the exception of Galyan's, which grew 23% -- but Dick's grew in a manner consistent with capital efficiency. That means inventories remained lean, debt was kept to modest levels, and free cash flow came in at a level almost equal to net income. As CEO Ed Stack boasted in the Q4 earnings release:
"Return on Invested Capital (with store leases capitalized) increased to 11.8% from 10.7% last year. Inventory turns increased 8 basis points to an industry leading 3.83 times, while gross profit margins increased 356 basis points for the fourth quarter due primarily to optimizing the favorable winter weather conditions."
Wow. This is a management team with its eye on the ball.
To be continued.
Next Monday, I'll pick up here and discuss Dick's sector-leading ROIC along with three other noteworthy positives. Until then, if you're in the eastern half of the U.S., check to see if there's a Dick's near you.
Matt Richey ([email protected]) is a senior analyst for The Motley Fool. At the time of publication, he owned shares of Dick's Sporting Goods. For Matt's best stock ideas and exclusive in-depth analysis each month, check out our newsletter, The Motley Fool Select . The Motley Fool is investors writing for investors.
