Sportsman’s Warehouse: Riches In Niches?
Naked came I out of my mother’s womb, and naked shall I return thither. The Lord gave, and the Lord hath taken away.
Job 21 (King James version)
What the pandemic gave, the re-opening is taking away. Shares of COVID-darlings like Clorox, Carvana, Etsy, Netflix, and Moderna have slumped 50-80% since November.
Back in 2020, many claimed that the pandemic would permanently alter consumer’s buying and travel patterns. This prognostication sent COVID-beneficiaries “to the moon.”
Now the world is re-opening and that forecast doesn’t look so prescient. Americans are moving back to cities, traveling, eating out, and shopping in person. Many COVID winners now trade below their pre-pandemic price.
The market’s miscalculation was an example of the age-old availability bias — humans tend to extrapolate the recent past infinitely into the future. In reality, no tree grows to the sky and reversion to the mean always curbs growth. While November 2021’s highs were too rosy, today’s lows may be too pessimistic. Time will tell.
Sportsman’s Warehouse is one of the COVID winners that looks interesting at current prices. The company operates 122 “no frills” warehouse stores that sell outdoors gear for hunting, shooting, fishing, and camping. They’re primarily located in the western United States in smaller markets that can’t support a Cabela’s or Bass Pro Shop.
Pre-pandemic, the company was muddling along with decent, if uninspiring results. Management doubled the store count from 56 at the 2014 IPO to 103 in 2019 and did so with stellar unit economics. The 57 stores opened achieved a 23% ROIC and a pre-tax payback period of 2.5 years.
Yet the stock was range bound from 2014-2019. SG&A increased from 25% of sales in 2014 to 29% in 2019, pinching margins. Gross margins slipped as the company’s sales mix shifted towards lower margin guns and ammo. And same-store sales fell 3.1% per year.
Guns and ammo are about 55% of sales, and Sportsman’s Warehouse relies on them to generate foot traffic that drives sales of other, higher margin gear. However, sales are idiosyncratic. They boom when fears that Democrats would ban them took hold, only to bust when nothing happens. This makes forecasting Sportsman’s Warehouse’s revenue more difficult than the typical retailer.
Fortunately for Sportsman’s Warehouse, hunting, shooting, fishing, and camping were among the safest activities in 2020 and 2021. Sales and profits boomed. The company paid off all of its debt and has authorized a repurchase big enough to buy back 18% of shares, which it expects to complete by the end of the year. The stock trades at just 4.5x trailing earnings.
The boom has lasted longer than anyone anticipated. Management’s best guess is that sales will decline 11-14% in Q2 (their fiscal Q1). However, take that with a grain of salt. No one, including management, predicted the magnitude of the boom. Don’t kid yourself that they have any idea how long it will last either.
All of this puts Sportsman’s Warehouse in an interesting, if uncertain position. If sales stabilize anywhere near their current run rate, the stock is extraordinarily cheap. However, if sales fall and stabilize closer to their 2019 or pre-pandemic patterns, the stock looks fully valued.
Source: Eagle Point Capital, Data From 10-Ks
The table above lays out four future scenarios that range from bearish on the left to bullish on the right. The reality is likely somewhere in the middle. Below, I’ll explain some of the pros and cons facing Sportsman’s Warehouse.
The Upside
Sportsman’s Warehouse is the clear number-two player in the big box hunting, fishing, and shooting retail market. The company got there by winning a war of attrition. Dick’s closed its Field & Stream stores, Gander Mountain went bankrupt, and Walmart and Dick’s decided to stop sell guns and ammo.
That leaves the Great American Outdoors Group, the parent company of both Bass Pro Shops and Cabela’s, and Sportsman’s Warehouse as the only nationally-scaled players in the big box outdoor retail market.
In February 2021 Sportsman’s Warehouse agreed to merge with Great American Outdoors Group for $18 per share in cash. In December the FTC rejected the merger on antitrust grounds and the Great American Outdoors Group paid Sportsman’s Warehouse a $55 million breakup fee.
Today Sportsman’s Warehouse trades around $9 per share, less than half of what a knowledgeable competitor thought it was worth. That it is the clear number two player in a duopoly is the main reason to be optimistic that Sportsman’s Warehouse’s future will be better than its pre-pandemic past.
Sportsman’s Warehouse sees a path to over 300 stores, almost 3x its current 122. They plan to open about 10 stores a year for now and expand their square footage 5-10% per year.
New builds have great unit economics. They cost $2.4 million to build and require another $2.4 million of initial inventory. Stores reach maturity within 18-24 months and pay back their cost in 2.5 years. Management targets greater than 10% four-wall EBITDA margins and a 20%+ pre-tax return on invested capital (including initial inventory) upon maturity. Historically, Sportsman’s Warehouse has exceeded these goals.
Mom-and-pop operators represent 65% of the outdoor retail market and should be easy pickings for Sportsman’s Warehouse’s scale advantages. The company should not need to go head-to-head with the Great Outdoor Group to gain share. Just as AutoZone and O’Reilly both grow while taking share from their sub-scale competitors, SPWH and Great American Outdoors Group should be able to grow without competing head to head with each other.
Sportsman’s Warehouse’s relationship with Great American Outdoors Group reminds of Dollar General and Walmart or Tractor Supply and Lowe’s/Home Depot. Sportsman’s Warehouse operates small stores in towns too small to support a Bass Pro Shop or Cabela’s. 61% of SPWH’s markets currently lack another nationally recognized outdoor specialty retailer. Bass Pro Shops and Cabela’s are large, capital-intensive destination stores that are uneconomical in smaller markets.
Regulatory restrictions create certain structural barriers to the online sale of a portion Sportsman’s Warehouse’s revenue, such as firearms, ammunition, certain cutlery, propane and reloading powder. Consumables accounted for 39.0% of 2021’s unit sales and 19.0% dollar sales. These are largely Amazon-proof and drive regular foot traffic.
That said, Sportsman’s Warehouse does face some competition from e-commerce. It is possible to buy ammo online. Guns can be bought online but must be delivered to a local dealer with a Federal Firearms License (FFL) that handles the pre-sale background checks. All of Sportsman’s Warehouse’s stores and its distribution center have FLLs so SPWH. The company’s e-commerce business soared during the pandemic and currently sits at 15% of sales.
Firearms dealers face significant regulation, which is only likely to increase. More regulation will favor the scaled incumbents like Sportsman’s Warehouse and Great American Outdoors Group, protecting them from new competition. For example, SPWH is required to keep records of transactions for up to twenty years. New legislation may require them to keep records indefinitely.
Sportsman’s Warehouse also reminds me of Alimentation Couch-Tarde in that it has a large relative scale advantage in a highly fragmented market. Alimentation has benefitted as retailers like CVS and Walgreens stopped selling tobacco, just as SPWH will benefit as Walmart and Dick’s have stoped selling guns and ammo.
For better or for worse, Sportsman’s Warehouse’s fortunes are tied to demand for guns and ammo.
The chart above shows that NICS background checks were steady between 1999 and 2010. Between 2010 and 2020 they oscillated between periods of boom and bust until exploding higher during the pandemic.
While prior booms relied on existing gun owners buying more guns, the COVID boom has relied on purchases by first-time owners. Sportsman’s Warehouse estimates that the number of firearm owners increased by about 12 million, or 12%. This suggests that some of SPWH’s COVID boom will stick around.
The COVID boom allowed Sportsman’s Warehouse to pay off of all its debts. Its strong balance sheet should be an asset going forward. The company’s strategy is to grow its store base by 5-10% per year. This will require almost all of the company’s operating cash flow, but ought to produce good returns. Presumably, as the company scales, its margins will improve.
The Downside
The argument against Sportsman’s Warehouse is that it is a largely undifferentiated retailer which must compete on price. Further, it experiences idiosyncratic sales patterns which make it difficult to forecast demand and manage inventory. Indeed, the company is currently sitting on significantly more inventory than usual, which has soaked up a lot of working capital. In the short term, liquidating it may boost free cash flow.
The sales boom over the last two years may have pulled forward demand rather than creating new demand. How many tents and fishing poles and guns do you need? One someone is fully kitted out, they’re presumably good for a few years. For example, Costco mentioned this week that since last year everyone went out and bought an outdoor grill and patio set, they’re selling much worse this year.
Sportsman’s Warehouse has a lot of characteristics I like, but none of them are quite strong enough to give me the conviction to buy it. Ultimately I don’t have conviction that I can forecast its same-store sales growth. The chart below shows how erratic they can be.
Sportsman’s Warehouse IPO’d in April 2014, just as same-store sales began to dive. If you’d bought into the IPO based on the historical track record of growth, you were likely disappointed. Besides the pandemic, which may be a one-off boost, same store sales are down since 2012. Without at least some same-store sales growth, Sportsman’s Warehouse is going to have a hard time hitting my return threshold.
So, I’ll continue to watch Sportsman’s Warehouse for now. If the company’s future is brighter than it’s past, its financials will show it, and I’ll buy it later once I am sure it is in replication mode.
For what it’s worth, Michael Burry, the investor behind The Big Short, recently bought the stock. It’s is his smallest position at 1.6% of his portfolio.
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