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
I’m not cussing JD Sports and its success. The gains delivered to shareholders is a dream that other companies can only fantasise. 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.
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.
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
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.
In fact, operating profits is £133m by 2016, a 1,900% increase from 2004.
WORKOUT FACT 2: JD SPORTS WIDE-RANGING BRANDS COLLECTION
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 JD’s portfolio. Also, by taking over these brands, JD lessen the competition and boost margins.
I won’t go into details why acquisitions make JD stronger because I will do a separate article. (So, watch this space)
WORKOUT FACT 3: SUPREME PROFITABILITY RATIOS
The improvement in JD’s 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
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.
WORKOUT FACT 5: GREENBLATT’S Return on Capital
One of Greenblatt’s magic formula, the returns on capital, is defined as EBIT 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 Greenblatt’s 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.
Using Greenblatt’s formula, the returns is 20%, when you ignore £80m in goodwill, £100m in borrowings. Also, we haven’t account for extra interest costs on the new borrowings.
By including all intangibles, (let’s 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 Greenblatt’s 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.
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, JD’s acquisitions strategies are 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 on the blue line, >1 = Sales greater than capex)
P.S. I use current year sales increase vs. previous year capex, to account for time-lag in generating the sales.
Over the 12-year period, every BRITISH POUND spent by JD, it manages to produce an extra £2.45 in sales. Even JD’s 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 realising the new JD store is within walking distance.
WORKOUT FACT 8: JD SPORTS, a CONSERVATIVE DIVIDEND-PAYER
JD’s 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 didn’t 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 the market value in 2004 average £90.95m and dividends paid total £13.82m. (£13.82m/£90.95m) *100 = 15.1%
WORKOUT FACT 9: JD’s MARKET VALUATION AT RECORD HIGHS
The company’s 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 JD’s shares looked overheated, but this post is about JD SPORTS making money for investors.
WORKOUT FACT 10: DON’T SLEEP ON JD’s SALES
You can’t dismiss JD’s revenue growth, especially when debt is in control.
JD’s 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: JD’s SUPERIOR CASH GENERATION
Measuring JD’s cash generation, you soon realised how well it generates cash. Using Cash Flow Return on Investment (CFROI), the percentage exceeds 100%. That is when you add the company’s debt and equity, but minus the cash, JD’s cash earnings exceed this on an annual basis.
This marks a big difference when it struggles to appreciate its market value as 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.
Now, the company is riding on £112m of net cash.
CALL TO ACTION
Are their facts that I missed?
What are your views on JD?
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