In this episode of Industry Focus: Consumer Goods, Motley Fool analysts Asit Sharma and Emily Flippen break down two recent retail earnings reports and discuss how the businesses are performing, their expectations for the future, and where they've each gone wrong in their past analysis.
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This video was recorded on August 31, 2021.
Emily Flippen: Welcome to Industry Focus. Today is Tuesday, August 31st, and I'm the host of this episode, Emily Flippen. Today I'm joined by Motley Fool Senior Analyst Asit Sharma as we talk about some retail earnings news. Hey, Asit, thanks for joining.
Asit Sharma: Emily, thanks for having me. I must say this morning, I'm in a sporting mood.
Flippen: It's a good pun for what we're going to talk about, and for our listeners who listen to both Industry Focus as well as one of our other podcasts and Motley Fool Money may be at least for our first story here, a little bit repetitive. That's because I covered this story on Motley Fool Money last week and was reminded that I probably owed our Industry Focus audience an apology on this business, which I roasted, I guess, last year. Around this time, last year I did pull Dick's Sporting Goods (DKS 1.01%) across the coals, and I'll tell you one thing: if 2021 has taught me something, it's taught me how to be very humble, because Dick's has performed extremely well this year.
Sharma: Emily, No. 1, I think you're humble to begin with. No. 2, I think you're quite a leader, because as I remember it, I was with you on that podcast and I joined in the roasting. I guess it would be easy for me to fly under the radar here and ask how it can be solved. You've been so harsh on Dick's Sporting Goods, but I think I was joining you a bit in that. So maybe we both have a little soul-searching for a couple corporations to do, but good results can change a narrative, right?
Flippen: It can, I'm not sure it has. Maybe my skepticism has continued, but at least mention the earnings before we get onto what it means for Dick's. This past quarter was really impressive. Sales grew over 20%. This time last year, sales were up 21% year-over-year. What was a pretty excellent year for Dick's when you think about the demand for things like outdoor equipment, camping gear, all of those benefits that came into 2020 for Dick's, they've done 20% sales growth on top of that, and same-store sales growth of nearly 20%, again, on top of that 21% last year. So they've continued a lot of their momentum from 2020 into 2021. They even issued a special dividend of over five dollars per share, significantly higher than their historic annual dividend, so for people who own this company who are income investors, I'm sure they were very pleased to see that come out. But virtually across the board, all the metrics for Dick's looked great in this most recent quarter and the stock price is certainly showing that.
Sharma: Yeah, Emily, in-store sales are up 40% year-over-year, and that's on top of 36% growth versus 2019. So great growth, even if COVID hadn't happened, that's one way we could interpret those results. They did as projected, have a decline in e-commerce sales, a 20% decline, that was still up 110% versus 2019. They also raised their full-year guidance for the second time this year. Now, with all this that we see, why were we so harsh on Dick's Sporting Goods last time around? Why did you call them out?
Flippen: I did pull out my old notes. Of course, I keep all the records from our podcasts in the past and I appreciate the enthusiasm with which I wrote about Dick's in our previous outlines and podcasts past. But it seems to boil down to a general belief that Dick wasn't performing well because of any actions on the part of management or their own strategy, but rather because of this tailwind that was happening to the entire industry. At the moment that tailwind stopped, Dick's wouldn't be in a better position to perform well in comparison to any other business in the market today, and that was to be frank, I think wrong. I think Dick's had actually made some strategic changes that went straight over my head. For instance, I was nervous about the over-investment into team sports inventory.
This time last year, management was very convinced that COVID cases were declining, headed into the fall, people, we're going to go back to school, more team sports we're going to come back. I thought to myself, well, there's no way this pandemic is over, so there's no way they're getting all of this sports demand back. They are probably going to have to pull back the guidance that they had raised for that year. What I didn't appreciate was not only the opportunities that would still happen even in a world where COVID cases are still accelerating. Team sports were the things that did come back. So management was right, but also just how many of those members they acquired in 2020, they managed to retain into 2021. So they had very strong retention of the nearly 8.5 million customers that they acquired last year. They acquired 2 million new customers this most recent quarter. Keeping those customers engaged beyond just the hiking and camping equipment was also something that I think are overlooked.
Sharma: It's funny that you should bring up the retention because that was something that I also thought would not be a factor. I felt that Dick's would have some sort of falloff from the great customer influx that they had during the height of the pandemic. But if you look around, the world is still in this middle-stage between total reopen and shutdown. It's very tentative to reopen around the world because of the Delta variant. Maybe there's still some vulnerability in that retention of this cohort they gained going forward. I don't know. This is interesting about going back-to-school as well, because that essentially was a bet that management placed and they could've been wrong on that. I have trouble with retail environments in understanding, especially fashion, how management teams can consistently make the right bets. How you rotate into what is going to be in a demand state, let's say two quarters from today or, or two years from today, the types of innovation that they've invested in.
You mentioned back-to-school, the team sports, as well as footwear, which is increasingly a space that Dicks is playing in, shops within stores, such as their soccer shops, and forays into golfing along with the teams work, which is actually a really persuasive volume driver for them. I get nervous around these. I feel that it says one thing about the management team that they have this very acute way of predicting what future demand will be. But it always reminds me of the retail business. You never know you could be totally wrong in one-year and that could hit your revenue and profits.
Flippen: I will say the stock is up over 150% over the past year. By no means should investors anchor to that price and think to themselves, well, that means the business is overvalued. Because whether or not a business it's overvalued or a good buy depends entirely on what we expect for the future, not what has happened in the past. But I say that just to show that the stock has appreciated. I think the unique aspects of Dick's that were maybe underappreciated, at least that I underappreciated last year. It begs the question of how much of this is repeatable? I think I have some thoughts here about the type of investor this business might be good for. But when you look at Dick's as it exists today, ignoring how wrong I've been over the past year, do you think that this is a business that it's worth analyzing more?
Sharma: Probably. In the consumer goods industry, you're set with a universe of companies that are only going to beat the rate of inflation by so much. That's the nature of the beast and consumer goods. Unless you have another component with which you can choose your revenue. For example, that tried-and-true example, Amazon.com, which has its whole software cloud business to support its retail sales, which are primarily e-commerce, also in grocery. You have to look at what is repeatable and also sustainable. I think they've built a base for decent, sustained performance. But you were talking about stock prices, Emily, and I was fixated on stock price, which is rare for me when we were researching this episode. Let's talk about it for just a bit.
You bring up such an interesting point, this mammoth appreciation over the last year. But over the past five and 10 years, Dick's Sporting Goods has actually under-performed the market until very recently. By very recently, I mean the last three trading sessions. I didn't look this morning, but go back to the earnings report which we've been talking about, the shares as of yesterday, were up about 28%. That's because investors got hit with this 1-2-3-4 punch. You had a strong quarter, the raised guidance we talked about, the special dividend you mentioned, also a 21% raise in the quarterly dividend. I think I'm up to five, so maybe five punches here. The announcement of a $400 million minimum share buyback target for this year. They have an authorization out that's a little bit less than $900 million. With all these factors, investors really took their skepticism off the table. But management has been telling us since last year that they were going to base their guidance for this year off of 2019. In other words, they were going to assume that the effects of COVID wouldn't be as sticky as some of their peers are assuming they will be.
We know they're going to lose some customers as things get back to normal. Hence, they've had to revise their earnings twice because of this conservatism. This plays into what they have been able to do with all the cash on the balance sheet that's excited shareholders. This 20% share price gain over the last few sessions, is what pushes Dick's up to a profitable investment versus the S&P 500 for both the five and 10-year periods. The longer-term story here, I think, still is one of skepticism about this big box retail model. Although they've got some convincing similarities with Target, which has been very successful over the past couple of years, and another company which we're going to talk about in just a minute. I won't give away which company this is. To me, this becomes more of a cash flow story. You're looking at a mature, big-box retailer that's really good with e-commerce, understands trends. They are trading at a price to free cash flow multiple of about 10 times. Now, that's less than half of what the company we're going to talk about trades around 23.5 times free cash flow, and Target trades at around 20 times free cash flow.
Dick's is going to have to earn multiple expansion, in my opinion, for this stock to pull off sustained performance over the next five or 10-year period. This is where I begin to question or where does that come from. Now I will be quiet and hear your thoughts on how and why they might have a repeatable performance that shareholders are very happy with over this past one, two year period.
Flippen: I still think that the idea for repeatable performance is going to be challenging for Dick's because 2020 and 2021 with these have been the definition of non-repeatable years. I hope, good Lord. Hope it's not a repeatable year. But the idea is that Dick's has been benefited by aspects that are outside of its control. Do I think it's going to have another year where it accelerates 150% in terms of share price performance? No, but I do think that if I was an income investor, I would feel somewhat comfortable holding these shares in a way that I didn't appreciate in the years past. I didn't appreciate the improvements that management has made to their merchandising strategy, what they do to engage their customers and their loyalty programs, and also just demand for the underlying product.
I think changing economic times, which includes the shift to retail, has put a lot of Dick's in-store competitors out of business and management still does see the value and having some retail footprints. Now we're seeing e-commerce businesses like Amazon come around to the idea of having a retail footprint. For those reasons, I'm less bearish, I'll say on Dick's than I have been in the past. Although admittedly, I do find that share price a hard pill to swallow today, which is why unless I was buying it for the total return here, just looking at the potential for capital gains, maybe I would be a bit more skeptical.
Sharma: I think that skepticism is warranted at last thought here, if you are an income investor, this company might make sense for us in terms of the dividends which Emily mentioned. But also the fact that if they can't find that multiple expansion, in other words, if they can't convince investors that there is a persuasive reason to push the share price higher, that there's some great revenue growth that is not dependent on unusual events around the corner, you do have a company which has a really solid balance sheet, is generating cash flow that they are trying to figure out what to do with it. Their store opening cadence has slowed over the past several years; it does have a big footprint for each store. Management is basically signaling to the market that we're going to start giving this cash back to shareholders. From that perspective, I think it becomes a little more attractive. Lastly, on this one, if I were a shareholder, I'd be looking at that footwear business. I think that's got some nice potential. I know before the pandemic, Dick's was really exploring introducing more private-label brands that they would own into the footwear areas in their stores. This would be something to watch because footwear can drive retail acceleration in the big box concept.
Flippen: Definitely. When we talk about this next business, I think it's a nice segue because in my personal investing history, the next business we're going to talk about is one that I have also made some mistakes with. It was actually the last business that I sold in my portfolio. One of the few sales I've ever made, I made this back in 2018. So yes, I haven't sold any stock and I believe it's been over three years now. The reason why was because when I bought the business, I was a fairly new investor. Not that I'm still not learning, but I was very early on in my investing journey. I bought the business, I held it for a number of, I believe, two or so years and I had seen that recently the stock price had appreciated greatly. Gone up something like 100%, 150% in just a matter of a year, a year-and-a-half. That made me nervous and I was convinced by another analyst that, oh yeah, this business, it's at its peak. You should sell it. I did sell it. In subsequent months, I believe it dropped by 30% or 40% on a bad earnings report. I felt very, very validated like, "I'm learning, this is what investing's like." Since that point, this stock has gone on to more than double. It is, in case you haven't figured it out yet, in case you haven't heard me tell this story before, Best Buy (BBY 0.66%). Yeah, so Best Buy, an amazing performing company, since the pandemic has obviously performed extremely well as well. They also had a strong earnings report over the last couple of weeks.
Sharma: Emily, I have a question before you jump into a quick recap and then we can discuss this bigger picture. Do you ever get back to that analyst and remind them what they said and demonstrate that, wow Best Buy wasn't anywhere near its peak? I'm just curious, you don't have to name the analysts.
Flippen: I would like to think that this person who does not work at The Fool, by the way, I would like to think that this person remembers our conversation and occasionally thinks to themselves. Maybe that was a bad call, but to be clear, I take full responsibility for that because as a new investor, I didn't have some of the critical things that I would need before buying a stock. One of those was a very clear thesis. I bought Best Buy without really understanding why I was buying the business that I was looking for in terms of performance. When I saw the short-term performance, I very much subject myself to those behavioral biases that so many investors can have. I thought to myself, "Well surely this isn't warranted." I didn't have a thesis. I saw great appreciation and I sold it. But more importantly, I then went to confirm that bias when I saw that for a little reason it had dropped significantly afterwards. Those are the things that make investors underperform in the market. Those are the things that make individual investors feel really good and then have performance that ends up being really bad and fortunate that obviously as younger at the time, this decision did not bankrupt me by any means. But it was a great learning experience. It's part of the reason why I have not sold an investment since I sold Best Buy. But I did, I missed that underlying thesis which was critical and my responsibility as an investor.
Sharma: Those are the best types of scenarios that can happen to an investor when that investor is at the beginning of their learning curve. Woe unto him or her who experiences these lessons after many years, so good on you. Well, earnings, Emily, revenue up 20% year-over-year to $11.9 billion. That was higher than analysts expected on a consensus basis of $11.5 billion. The earnings were also up very strongly, 75% year-over-year $2.98 per share versus $1.85, which was expected by analysts. Same-store sales up 20% year-over-year versus just 6% in 2020. I would've thought this would be a hard comparison. I was a little surprised by that number.
Flippen: I am shocked as well, in part because I think I had some concerns regarding the chip shortages and how this may impact the demand and ability for Best Buy to meet its supplies. I think the demand for these equipment, still there, Best Buy, still performing well. But I was surprised to see that there was very little impact on their actual store distribution and fulfillment of these underlying items. It hasn't happened yet. Their supply chain has not been impacted by the chip shortage. I wonder how long this chip shortage has to go on before it starts to show up in Best Buy's performance. But for the time being Best Buy is doing well in part because they're selling more things like appliances, phones, home theaters, all of the things that I think people may have thought we stocked up on in 2020, apparently we didn't.
Sharma: Maybe we are stocking up on those even past the peak of COVID because we're hearing about this chip shortage. We want to go out and buy those phones that we've been looking at before we find that they are out of our reach. Another thing that you pointed out in our notes when we were researching this episode is their store-based fulfillment model. That helps keep costs low. You noted to me that 60% of their online revenue was fulfilled by stores with things like in-store or curbside pickup. That seemed very Target-like to me. Target has done a wonderful job of fulfilling e-commerce sales out of their stores. You have an instance of another company that was working on this model before COVID obviously, and it just kept capitalizing on that.
Flippen: I like the change in consumer behavior that's persisting into 2021. I think we expected some level of things like in-store pickup or curbside pickup to continue even if the pandemic was flipped like a switch off. I don't think I expected it to continue at the same rate that it has been. I will be interested if this ticks down overtime. But for the time being, actually having a physical store seems to be an advantage. Even as we all get back to work and spread out, people seem more willing as opposed to ordering something online to order it to a store, drive by, pick it up maybe on their way to work, on their way home from getting food, whatever it may be. I do like it. It keeps costs much lower for the businesses themselves and lets them compete more readily with the natural e-commerce players. It almost gives them an advantage over natural e-commerce players by having your retail footprint, which I think if I had said that five years ago, people would have rolled their eyes. But I think we're seeing the reality of it today.
Sharma: We're starting to understand why that footprint can be important. Emily, I had an apparel experience with you last week. I was on MarketFoolery and I was talking about Best Buy and lamenting that I had ignored this stock for a long time. One of the things I pointed out in that episode was management's innovative muscle. You note that Best Buy has been testing their Geek Squad package into something now which is going to be subscription-based called Total Tech. This is a $199 a year subscription service. You get unlimited tech support, premium service, product protection, free delivery, all kinds of things. This to me proves something that I was skeptical about and just missed from several years ago. Why would people pay other people to come to your house and fix things that you could mostly fix on your own. This is mostly software-related assistance that you might need with your computer. But it turns out there is a huge market for people who still aren't comfortable with basic hardware software issues.
Of course, you do have issues where your computer does break down, The Geek Squad is there, but they are really ramping up that offering into something that is going to be even higher margin for the company. Interesting that the CEO, Corie Sue Barry mentioned in their earnings call that with this ramp up into a more comprehensive offering on the side, it's not going to help out margins in the near-term. They're making an investment. But I see this over time as improving long term customer value, driving more of the CE, consumer electronics spend. Which means that they will push people back into stores because they are still loyal and they love the subscription, they'll end up buying more consumer electronics, which is a big focus area for management. This with some store testing seems to me a sign that I missed that the company is pretty innovative because it's stuck with this big box format.
Flippen: One of the things that I loved most about this offering was just how they're thinking about making people comfortable with tech support. It's been this area that I think consumers have just felt like they have been on their own. You have an issue, you have to figure it out on your own. You have to Google it, you have to trial things. They're trying to say things like, ''We've been ignoring this aspect of annoyance, I guess, in consumers' lives. Let's actually have an offering that can fix these problems." That includes things like getting on your phone and talking to a tech support agent right there. If you're looking to make a purchase, go into your kitchen, maybe you're getting an appliance. Share your screens. Show them your kitchen. Get advice about the size of TV or the equipment that you would use best. I like that aspect because it feels very forward-looking. But to your point, Best Buy has just been a machine and while it generates a ton of cash, I'm not sure that all of these initiatives will work, but I think once that will, will but probably end up sustaining growth for this business in a way that it's underappreciated in the market right now. I also saw that they are moving into potentially new categories, things like outdoor living. They're trying to meet the market where the market is.
Sharma: Yeah. You have to experiment, that's for sure. I guess last quick points before we wrap up here, I did some soul-searching since my MarketFoolery appearance last week. Here's what I think I missed, some other aspects of the story. Sales efficiency is really high. In fiscal 2016, Best Buy had $836 of revenue per square foot. Fast-forward to today, it's about $1,122 of revenue per square foot. They're really efficient in lowering that store footprint and selling more per square foot. I didn't see how much they would end up selling in their computing and mobile phones segment. That's 46% of their revenue in fiscal 2021. That obviously has this experiential element, you like going to a store, checking out the phones before you buy, and the same with laptops, computers, and tablets. I totally missed that. I missed this very Target-like build-out of the e-commerce fulfillment capabilities from in-store. I missed that the company is really savvy with its labor. They tend to cross-train employees quite a bit. They want to even have in the future, what they call virtual stores, which are actually real stores that you can't walk into, but they are staffed with people who you can communicate with via video. You're shopping on the site, or you're in a real Best Buy store, you can dial into a real person who's in a mock store who will walk around and demonstrate the product. A lot of innovation and focus on lowering labor costs as well. There's a lot here to this story that I missed. But thankfully, I don't have the pain of having bought and sold out earlier.
Flippen: Maybe ask you an impossible question. If you had to buy one of these businesses between Dick's and Best Buy, which one stands out to you? I think for me, it's Best Buy. I've done this business wrong in the past, so I think that's where my vote goes. What about yourself?
Sharma: I think Best Buy as well, because they are focusing on so many things which can just make them a little bit more stable than Dick's is. They've done so much heavy lifting in the past few years. I think they are ahead of where Dick's is. Very much for me would be Best Buy. That is an impossible question, but on the spot, yeah.
Flippen: Inevitably, next-quarter, Dick's is going to be up another 30%, 40%. Just because of what we said here.
Sharma: We will punish ourselves by revisiting it right here.
Flippen: Well, Asit, as always thank you so much for joining.
Sharma: Thanks for having me, Emily.
Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out and say "Hi," shoot us an email at [email protected] or tweet us @MFIndustryFocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I'm Emily Flippen. Thanks for listening and Fool on.
