April 13, 2017

Authored by: Walter Hin

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.

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Company name: JD

Sports PLC

Ticker: JD

Exchange: Main

Market (FTSE 250)

CEO: Peter Cowgill

Current Share Price:

450p/share

MKT. CAP. (£m):

£4.37bn

Shares Outstanding:

973m

Free Float: 402m

P/E: 24

Dividend Yield:

0.34%

Net Cash: £214m

Shareholders’ Equity:

£552m

SUMMARY

-The share price is up 1,584% in the

last decade. (i.e. Invest £10,000 and it

turns into £158,400!)

-This share price appreciation didn’t

happen in the previous decade (1996-

2006) when the shares lost 8%.

-JD owns a lot of brands through

acquisitions, such as Cloggs, Blacks,

Millets, Chausports and Ultimate

Outdoors.

-The Sportswear increased their real

estate from 1.2m Sq. Ft. to 3.5m Sq. Ft.

in ten years.

-JD been growing its revenue at a

compound rate of 12.2% per year.

-JD’s operating margins improve from

1.8% during 2004/05 to 8%.

-JD bought Blacks Leisure for £20m,

when the business was generating

£200m in Sales.

-It bought Canterbury Europe for £6.5m

in 2009 and sold it three years later for

£22.7m for 170% return on investment.

Their most recent acquisition was a

£112.3m deal for Go Outdoors that

makes £3.7m in net profit.

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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

I’m 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

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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.

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.

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 JD’s portfolio. Also, by taking

over these brands, JD lessen the competition and boost margins.

I won’t 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

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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

GRAPH 4

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: GREENBLATT’S Return on Capital

GRAPH 5

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.

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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.

GRAPH 6

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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 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

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 realizing the new JD store is within

walking distance.

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

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GRAPH 8

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 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: JD’s MARKET VALUATION AT RECORD HIGHS

GRAPH 9

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.

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WORKOUT FACT 10: DON’T SLEEP ON JD’s SALES

You can’t dismiss JD’s revenue growth, especially when debt is in control.

GRAPH 10

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 realized 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.

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GRAPH 11

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.

GRAPH 12

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Now, the company is riding on £112m of net cash.

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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:

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

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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 JD’s 500 stores. Also, Blacks has

sales of £200m. Below is the details of the subsidiary business:

Table 2

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

JD’s 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 2016’s 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:

Table 3

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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 can’t argue that JD turnaround (the closure of 130 Blacks stores)

would make Blacks profitable today.

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 2016’s 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 can’t 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

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 JD’s post, I discuss one factor of share price appreciation

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 JD’s 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”

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?”

Thanks for Reading and please take the time to Subscribe, Like and

Share my post.

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My Website: http://walbrockresearch.com/home/

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