Trade Idea – Bag of $DKS

by Dan November 17, 2015 3:49 pm • Commentary

2015 may be remembered as the year the U.S. consumer Netflix’d and Chilled.  In between episodes of House of Cards and Orange is the New Black, Americans bought their organic foods from their Instacart app, their dinner from their Seamless app, and almost everything else they need to survive from, all to be delivered.  There is little doubt that our laziness has manifested itself in a healthy jump in video streaming hours for the likes of NFLX, Hulu, Facebook & Google, but I’ll save that for another post.  Let’s focus on that sound in the background, which very much resembles a death rattle for bricks and mortar retailers.  In the last month we have seen the stock’s of big box retailers like Walmart, department stores like DDS, JCP, JWN, KSS and Macy’s, high end retailers like COH, KORS & TIF, teen apparel ANF, GPS & URBN and consumer electronic and video game shops like BBY and GME all IMPLODE.

There have been outliers like COST and HD, but they have been few and far between and prior stalwarts like NKE & UA are now under considerable pressure.  Make no mistake, something is going on here, and I am not sure it is exactly a zero-sum game that will ultimately benefit investors.

Today’s disaster du jour is Dick’s Sporting Goods (DKS).  This morning the company missed their Q3 estimates and guided the full year down from a prior mid-point of $3.17 to $2.92, or by about 8%.  DKS is down about 11% as I write, but up considerably from its lows, when the stock was down about 18% at 10am.  If the company is able to report $2.92 for the year, then the stock is trading about 12.5x expected earnings growth that is now only up about 2% year over year, placing its P/E very near a ten year low:

DKS 10 year chart of P/E from Bloomberg
DKS 10 year chart of P/E from Bloomberg

Big box & specialty  retailers like DKS very well may be a thing of the past, but I would be very surprised if all of the retail outfits I listed above trading at 52 week or multi-year lows are doing so because investors are making bets that they are done.  I suspect we soon start to hear about consolidation, companies being taken private.  DKS for instance has a $4.3 billion market cap, only $350 million in debt and trades about .5x next year’s expected sales of $8 billion.  There has to be some sort of omni-channel solution for a company like DKS, combined with another retailer that could get the sort of scale that would stave off what any imminent demise.

The 8 year chart from DKS’s financial crisis lows show the healthy uptrend, the stock’s break of trend last year, its miraculous comeback to new all time highs this past spring, and now multi-year lows.  A re-test of long term support at $30 could very well be in the cards, but that is another 20% away:

DKS 8 year chart from Bloomberg
DKS 8 year chart from Bloomberg

Options prices have come in hard with the stock settling into a range after the morning’s collapse, and 30 day at the money implied volatility should come back into the low 30s in the coming days/weeks:

DKS 1yr chart of 30 day at the money IV from Bloomberg
DKS 1yr chart of 30 day at the money IV from Bloomberg

We don’t like the stock here and would prefer to step in closer to the $30 support level, but for those looking to play for a bounce, or believe that the massive m&a trend in almost every other sector in the market is likely to find its way into retail, and DKS, unlevered balance sheet, and cheap valuation could make it a target, then you may want to look to define a wide range, both up and down where you would have long exposure. Rather than buying the stock at current levels, risk reversals could make sense.

Bullish Trade Idea:

DKS ($36.50) Buy the Jan 30/42 risk reversal for even
  • Sell to open 1 Jan 30 put at .40
  • Buy to open 1 Jan 42 call for .40

Rationale – With what’s been going on in bricks and mortar retail it’s probably not wise to just step in and buy a stock like DKS. For those worried about entry risk reversals make sense, selling a put at long term support to own an upside call that could quickly be in the money with any news or sudden changes in sentiment.

We are going to be a little patient here and see if the stock can try to put in a bottom in the coming days in the mid $30s.