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12 Reasons Why JD Sports is the King of

Trainers

An analytical study of why JD Sports Fashion became successful

BONUS MATERIAL: The Real Reason behind JD Sports is


through Acquisitions made at the Right Price.

April 13, 2017


Authored by: Walter Hin
SUMMARY Company name: JD
-The share price is up 1,584% in the Sports PLC
last decade. (i.e. Invest 10,000 and it
turns into 158,400!) Ticker: JD
-This share price appreciation didnt Exchange: Main
happen in the previous decade (1996-
2006) when the shares lost 8%. Market (FTSE 250)
-JD owns a lot of brands through
CEO: Peter Cowgill
acquisitions, such as Cloggs, Blacks,
Millets, Chausports and Ultimate
Current Share Price:
Outdoors.
450p/share
-The Sportswear increased their real
estate from 1.2m Sq. Ft. to 3.5m Sq. Ft.
MKT. CAP. (m):
in ten years.
4.37bn
-JD been growing its revenue at a
compound rate of 12.2% per year.
Shares Outstanding:
-JDs operating margins improve from
1.8% during 2004/05 to 8%.
973m
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

-JD bought Blacks Leisure for 20m, Free Float: 402m


when the business was generating
200m in Sales. P/E: 24
-It bought Canterbury Europe for 6.5m
in 2009 and sold it three years later for Dividend Yield:
22.7m for 170% return on investment. 0.34%
Their most recent acquisition was a
112.3m deal for Go Outdoors that Net Cash: 214m
makes 3.7m in net profit.
Shareholders Equity:
552m

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Shareholders in JD Sports (LSE: JD) are pleased with the reward for buying and
holding this stock. If you ignore dividends, capital appreciation gains are
1,584% in the last decade. (i.e. Invest 10,000 and it turns into 158,400!) And
the unique selling point of JD? It distributes brands sportswear and acquired
failing outdoor and sportswear brands.

JD Sports not that Special


Im not cussing JD Sports and its success. The gains delivered to shareholders
is a dream that other companies can only fantasize. But, there is nothing special
about JD Sports (I mean the standalone brand).

What do I mean?

Prior, to the colossal gains between 2007 and 2017, the previous decade before
that, its market performance was mediocre.

GRAPH 1

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

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The market valuation of JD in the beginning of 1996 was 134m and ended 2006
with a market value of 139m. In share price terms, you would have lost 8% of
your initial capital.
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

So, what has transformed JD Sports into the powerhouse that it is today?

Here are 12 facts that contribute to making the king of selling trainers great.

12 THINGS THAT GOT JD SPORTS SHAREHOLDERS


1,584% GAINS

WORKOUT FACT 1: RISING PROFITS AND INCREASING MARGINS

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GRAPH 2

Notice the first three years, JD barely earns 8m per year, and operating margins
was a small 1.5%. From 2007 onwards, other sports retailers begun to unravel.
JD started to see improvement in margins and absolute profits.

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017


In fact, operating profits is 133m by 2016, a 1,900% increase from 2004.

WORKOUT FACT 2: JD SPORTS WIDE-RANGING BRANDS COLLECTION

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Apart from the above brand logos, JD, also owned Chausports, Splinter, Kooga,
Kukri, Get The Label, Focus, Source Lab, Tessuti, Cloggs, Nicholas Deakins,
Mainline, Blacks, Millets, Tiso and Ultimate Outdoors.

That is a lot of brands and extra store fronts under JDs portfolio. Also, by taking
over these brands, JD lessen the competition and boost margins.

I wont go into details why acquisitions makes JD stronger because I will do a


separate article. (So, watch this space)

WORKOUT FACT 3: SUPERME PROFITABILITY RATIOS

GRAPH 3
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

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The improvement in JDs profitability ratios played a part in increasing its market
value. Higher returns mean higher margins, but it also means there is a likelihood
of earning positive free cash flow.

WORKOUT 4: JD POSITIVE + INCREASING FREE CASH FLOW

GRAPH 4

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

As mentioned earlier, JD Sports earn positive free cash flow, despite its
acquisitions spree. With free cash flow, JD can choose to built-up its war chest or
payout extra dividends from internal operations.

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WORKOUT FACT 5: GREENBLATTS Return on Capital

GRAPH 5

One of Greenblatts magic formula, the returns on capital is defined as EBIT


12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

over tangible assets and net working capital less cash. JD is able to
earn over 100%, based on the required assets needed to keep operations
running smoothly. (While it ignores intangibles, cash and debt.)

One weakness of Greenblatts formula is ignoring debt, especially when it is used


to acquire businesses. (this tends to include goodwill, in most cases)

For example, a company buys a business for 100m, but the net value is 20m.
It also earns EBIT of 5m. The company borrows the 100m from the banks to
do the deal. The accounting transaction would be:

20m Tangible assets; 80m Goodwill, and 100m Total Borrowings.

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Using Greenblatts formula, the returns is 20%, when you ignore 80m in
goodwill, 100m in borrowings. Also, we havent account for extra interest costs
on the new borrowings.

By including all intangibles, (lets say there is a 4% interest on the 100m of


borrowings), the returns would be 1%!

5m minus 4m (interest costs) = 1m, then the (1m/100m) *100 = 1%!

The reason that validates Greenblatts formula for JD Sports is total debt is low at
6.75m (been declining for years). Intangible assets saw an increase of 20m in
six years, while sales up by 150%. Plus, there is a cash build-up to 215m.

WORKOUT FACT 6: ASSETS ARE GETTING YOUNGER

The number of stores and retail space that JD Sports occupy on the High Street
has increased from 1.2m Sq. Ft. in 2007 to 3.5m Sq. Ft. in ten years.

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017


GRAPH 6

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12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

With younger assets and increasing earnings, what not to like about JD? Also,
JD is able to acquires without incurring excessive Acquisition Costs, meaning
less goodwill on its balance sheet. Also, debt is tiny (6m vs. net profit of
133m).

As I said earlier, JDs acquisitions strategies is key to its success.

WORKOUT FACT 7: JD CAPEX SPENDING MONEY WISELY

Apart from the blip in 2014, JD manages to increase sales greater than capital
investment. (shown in the blue line, >1 = Sales greater than capex)

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P.S. I use current year sales increase vs. previous year capex, to account for
time-lag in generating the sales.

GRAPH 7

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017


Over the 12-year period, every BRITISH POUND spent by JD, it manages to
produce an extra 2.45 in sales. Even JDs operating profits covers capex at
1.07X in the same period.

Investors should remember that capital investment can generate new sales two,
three or four years into the future. This is because the stores become more
efficient over time. And more customers realizing the new JD store is within
walking distance.

WORKOUT FACT 8: JD SPORTS, a CONSERVATIVE DIVIDEND-PAYER

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GRAPH 8
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

JDs dividend yield is the lowest since 2004 at 0.54%. Instead, the sportswear
distributor has cleared up its debts and build its cash reserves in the bank
balance. (which stands at a record high of 215m) Clearly, this didnt affect the
share price.

Also, JD can (easily) pay more dividends, as the dividend payout ratio is 0.13,
thus translates to 7.28 times dividend cover.

Long-time holders of JD Sports (if you held the stock for 12 years), would see the
current level of dividends equate to 15.1% dividend yield. That is because market
value in 2004 average 90.95m and dividends paid total 13.82m.
(13.82m/90.95m) *100 = 15.1%

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WORKOUT FACT 9: JDs MARKET VALUATION AT RECORD HIGHS

GRAPH 9

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

The companys EV/EBIT Ratio touches all-time high at 25 times with PE Ratio
clocking in at 37 times (highest since 2007). We can speculate and make
suggestions that JDs shares looked overheated, but this post is about JD
SPORTS making money for investors.

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WORKOUT FACT 10: DONT SLEEP ON JDs SALES

You cant dismiss JDs revenue growth, especially when debt is in control.

GRAPH 10
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

JDs revenue growth is so great it averages at a compound rate of 12.2% per


year. (Fund managers would kill for this kind of returns, even if its vanity)

WORKOUT FACT 11: JDs SUPERIOR CASH GENERATION

Measuring JDs cash generation, you soon realized how well it generates cash.
Using Cash Flow Return on Investment (CFROI), the percentage exceeds 100%.
That is when you add the companys debt and equity, but minus the cash, JDs
cash earnings exceed this on an annual basis.

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GRAPH 11

This marks a big difference when it struggles to appreciate its market value as

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017


CFROI fails to exceed 25% between 2004 and 2006.

WORKOUT FACT 12: JD HAS REAL NET CASH

People use TOTAL DEBT minus TOTAL CASH to derive net debt/cash. A more
realistic and accurate measure is to account for prepayments and accruals. So,
net cash/debt is: CASH + Receivables minus total debt and payables.

GRAPH 12

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12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

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Now, the company is riding on 112m of net cash.
Bonus Material: The Real Reason behind JD Sports is
through Acquisitions made at the Right Price

One contributing factor to JD Sports success is their acquisition strategies.

Making the right acquisition and at the right price in the right business cycle
is what makes JD so successful.

Here is a table of JD Sports acquisitions:

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017


Below is a detail look at seven acquisitions that JD has made. Some will
include previous financial results, so you can judge whether these are good
acquisitions.

Afterwards, we evaluate how these acquisitions propelled the status and


branding of JD Sports.

The Seven Acquisitions made by JD Sports

Chausport

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In 2009, JD bought this French Sportswear for 8m or 7m. The
accounts ending in December 2007 has reported a turnover of 40.7
million and pre-tax profits of 600,000.

The 78 stores obtained by JD Sports would help promote themselves in the


French market.

Canterbury Europe

JD bought this business for 6.5m in 2009 but then sold it to Pentland
Group for 22.7m, three years later.

At the time of purchase, Canterbury Europe had sales of 29m with


operating loss of 500,000.

That sales made JD 16.2m or 170% investment return.

Regardless, here is a brief financial history of Canterbury Europe.

Table
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

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BLACKS Leisure

In 2012, JD Sports made the winning bid and bought Blacks Leisure for
20m. The money goes to paying the loans Blacks owed to the banks
leaving their shareholders in the dust.

Go to the Companies House website, last accounts filed were for 2011. In
it, Blacks owned three brands (Blacks, Millets and Freespirit). The
subsidiary has a total of 308 stores to JDs 500 stores. Also, Blacks has
sales of 200m. Below is the details of the subsidiary business:

Table 2

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017


How does this acquisition compare with JD Sports
valuation?

On the basis of sales, JD bought Blacks on a Price to sales = 0.1, while


JDs sales value it on P/S of 0.31.

On a Price to Book basis, the market values JD at 1.6 times, whereas JD


bought Blacks on 0.6 times.

What makes this acquisition successful?

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Remember, I mentioned 308 stores (ignoring Freespirit, this goes down to
290) owned by Blacks before JD Sports acquired it.

On 2016s JD Sports annual report, the total numbers of Blacks and Millets
store, combined fell to approx. 160. The closure of 130 stores would lead
to lower sales. So, this would increase operational efficiency leading to
profitability.

Kukri Sports Limited

JD bought this kit manufacturer for more than a 1m (assume it is under


2m) in 2011. More accurately, it was an 80% majority stake in the
company. Turnover for Kukri in 2010 is 13m, but has negative equity of
2.3m.
This is Kukri Sports financials in the last three years:
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

Table 3

3
Champion Sports (Holdings)

JD Sports bought Champion for 20m. Champion has a turnover of 54m


in 2009.

Go Outdoors

In one of JD biggest and latest acquisition is this outdoor retailer for


112.3m deal. It has revenue of 202.2m with a 4.9m profit before tax or
3.7m in net profit.

The company operates 58 stores in the UK, which was owned by private
equity owners YFM Equity Partners and 3i Group.

This business has similar revenue numbers to Blacks, but JD paid six
times more for Blacks. At least Go Outdoors is expanding and profitable,
but we cant argue that JD turnaround (the closure of 130 Blacks stores)
would make Blacks profitable today.

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017


Only time will tell if this latest acquisition earns JD Sports high returns from
investments.

Below are the financial numbers for Go Outdoors:

Table 4

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Sports Unlimited Retail BV

Another 2016s acquisition is two Dutch Sports Business by setting up a


new Dutch subsidiary called Sports Unlimited Retail BV. The names of the
two businesses are called Aktiesport and Perry Sport.

The thing is JD buys them from a Trustee called Unlimited Sports Group
BV. Afterwards, it will declare bankruptcy (you cant make this stuff up).

The cash consideration of 26.5m (20.9m) is payable. But excludes


fees, retention of title and other claims arising consequent upon the
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

bankruptcy process.

On both these businesses financials:

For the year ended 31 December 2014, the combined Aktiesport and
Perry Sports businesses delivered consolidated revenues of 159.4m, an
operating profit of 1.5m, a profit before tax of 0.2m and gross assets of
67.4m.

Okay, we learn a lot about JD acquisition strategy, although some of them


are new and require time to pan out.

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What have we learned from these acquisitions?

JD Sports acquired 657m of sales for 184m

The ultimate truth of JD Sports secret recipe for acquisition revealed.

About the seven acquisitions made by JD and mentioned in this post.

JD bought in sales of 657m by paying 184m for these businesses. That


is 0.28 times of acquired sales. Meanwhile, JD Sports has an average price
to sales ratio of 0.52 times in the past eight years.

Remember, if JD Sports pursue a cost-cutting strategy, then further


reduction in sales is likely, but with a higher probability of profitability. But,
at the same time, if JD market their brands alongside the acquired brands it
would increase sales.

Why JD manages to increase margins?

In my last JDs post, I discuss one factor of share price appreciation

12 Reasons Why JD Sports is the King of Trainers | 4/13/2017


success is down to the ability to increase their margins. (the link is found at
the beginning of the post)

That big contributing factor is down to the reduction in competition at the


domestic UK markets. Secondly, JD management acts like private equity
firms. By cutting excess cuts and turning their subsidiaries around.

Lastly, JD bought these businesses at the bottom of the market or from an


administration. That means JD did not need to borrow money externally
(saving interest costs). Also, they pay as low as possible to shorten
payback period and can generate higher returns from investments.

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So, is it surprising that JD manages to achieve capital gains of over
1,500% between 2007 to 2016? Compare that to the previous decade
(1996 to 2006), JD shareholders lost 8% on initial investment!

Call to Action
Are their facts that I missed?
What are your views on JD?
So, have you learn anything from JDs acquisition strategies?
Or, are there other factors I have not mentioned which are
detrimental to JD success?

For those who want to Comment, please refer back to the link of the
original article on my website at Walbrock Research:
A. 12 REASONS WHY JD SPORTS IS THE KING OF SELLING
TRAINERS
12 Reasons Why JD Sports is the King of Trainers | 4/13/2017

B. Learn why acquisitions make JD Sports more competitive

If you like these articles, then you might be interested in Debenhams PLC
and French Connection:
1. Should you invest in Debenhams PLC for retirement income?
2. Why French Connection should change course before the retail
curse swallow it up?

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12 Reasons Why JD Sports is the King of Trainers | 4/13/2017