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Sports Direct, the stock ’em high sell ’em cheap sports retailer has lost 60% of its value since in just one year and it cannot have escaped your notice that it has been routinely lambasted by politicians, regulators and shareholders alike over the same period. Today the shares trade around 300p, this capitalises the company at £1.8bn, with only modest net debt the Enterprise Value is around the same level. So with the shares trading on a forward P/E of 11, has all the downside been priced in already?
What went wrong?
The results year ended to 24/04/2016 (the most random year end date on LSE) look reasonable at first glance, see fig 1 below which shows increase in revenue and a flat EBITDA, but when you look deeper into the financial statements, Cashflow from Operation fell from £236m to £65m and cash from investments were -£98m. This meant the company generated -£33m Free Cash flow (FCF). Compare this to the prior year when Sports Direct generated £158m of FCF. The primary difference was a whopping £155m increase in inventory and given that revenues remained fairly flat it is concerning to see inventories increasing by 35%. Reading through the material Sports Direct has issued for the year end I can’t see any real explanation for this huge movement other than ‘timing’. This does concern me and something I can’t see many analysts have really picked up on.
Instead the two key reasons that the market has focused on are firstly the cost of the goods which Sports Direct stocks and pays for in US$. As you know the GBP:US$ has plunged to a 20 year low and Sports Direct has no hedging in place. This is appalling risk management which is expected to take at least 5-10% out of FY17 Earnings.
The second reason is the huge reputational damage Sports Direct has received by the way it treats its workers. This shows how out of touch Sports Direct is with how modern corporates operate and the Corporate Social Responsibility expected of them. It is no surprise to me though, there is so little diversity at the most senior levels of the company to bring in any fresh perspectives!
There is also another factor, one that is not new but has been bought back to the surface. Sports Direct has the worst Corporate Governance in the FTSE350 by an absolute mile, there are even some companies at the bottom end of AIM who probably fair better that Sports Direct in this department. A few examples; the board has been missing a CFO since 2013, Mike Ashley’s daughter’s boyfriends has been appointed as Sports Direct’s head of property, earning around £2.5m as a consultant. P.S. his CV is hardly relevant nor glittering with recent positions include ‘running student parties’. Further, the board is almost entirely made up of Ashleys long term associates. When you consider the above and that Ashley has the majority of the shares of Sports Direct then there is only one conclusion, Sports Direct is really a private company in disguise.
By the way there are only limited macro issues at play here, in fact when you compare to a rival player JD sports, you will see the two companies are almost symmetrical in their share price performances. JD has recently hit an all time record share price whilst Sports Direct has gone about destroying shareholder value.
Any other concerns?
If you take a look at the 2016 Sports Direct Annual Report can you coherently tell me the strategy? There isn’t a coherent strategy in my view, take a look at Fig 3 below. What does this mean? Sports Direct makes it clear the extent of its empire further up in the annual report, but what is the purpose which joins them all of the portfolio together?
I do see some progress in forming a strategy in it’s recent Investor Presentation where it notes a ‘Fundamental strategic intention to take Sports Direct in the direction of the “Selfridges” of Sports Retail (and beyond)’. Excuse me? I don’t know what Sports Direct means by this, but if they think they can drop their cheap and cheerful approach and become a luxury brand they may as well hit the self destruct button now.
One final thing which irks me is the focus on property purchases, if I wanted to speculate on commercial property I would buy British Land….
All this is dreadful. Is there any hope for the future?
Guidance for FY17 is around £300m EBITDA, we could therefore expect PAT of around £150m-£180m, this would place Sports Direct on a P/E of around 10, which is fairly cheap but you could also consider this very expensive given the lack of governance, poor approach to Corporate Social Responsibility (CSR) and strategic confusion. Sports Direct has very low gearing with net debt being just £99m and plenty of access to undrawn facilities if required. There is also a fair bit of Asset backing (much of it tangible), NAV is £1.3bn, i.e 72% of the market capitalisation which is large for a retailer, JD for example has just 15% book value:Market Capitalisation. Sports Direct is certainly not distressed and thus still has plenty of opportunities to turn things around. So Is there any glimmers of hope at all it can do so?
Possibly. Sports Direct has just reluctantly agreed to independent ‘360 review‘, which will cover CSR and corporate governance and be delivered in 2017. We all know this report will be full of red flags, the important part though will be whether Sports Direct choses to implement any of the findings. This will be the acid test of whether Sports Direct is investment grade.
Neutral. Buying opportunities may exist below 250p, Sell above 350p (Assumes all other things equal)
There is no doubt Ashley is entrepreneurial, you can’t be an idiot and build a company of this size. The company is also cheap on a forward PE of 10. That said it is red flag central at Sports Direct and I would want to look for solid progress on CSR, Strategy and improving Corporate Governance before issuing a buy here.
Disclaimer – I have a long position equal to 1% of my net assets in Sports Direct bought in at 307p. I have no further positions in any of the other stocks mentioned and to my knowledge nor do any close family, friends nor associates.
This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.