Sports Direct – great value or unsustainable?

Mike Ashley is back in charge of Sports Direct – not that he ever really left with a 55% stake in the business. There have been some widely advertised problems at the sports retailer over the last couple of months including his refusal to let his Chairman go – with the result (if they are related) of losing his much better regarded CEO Dave Forsey. The underpaying of employees in their main warehouse has obviously also filled miles of print for journalists recently, although Sports Direct seem to be the poster boy in that instance of a practice that is more common than you would think. This has been fixed relatively swiftly including a promise to repay previous under payments. I was amused to read that Ashley’s daughter’s 27 year old boyfriend has been given a very well remunerated position looking after the property portfolio – so using investor money to look after the family possibly?

So is Sports Direct (LSE:SPD) a basket case that should be left well alone given the management problems or do the management problems make it great value? Before I get into the accounts, let me just make a couple of points regarding Ashley. 1) He knows how to run a sports shop 2) He doesn’t seem very nice but you are unlikely to ever meet him. I would argue that any investment decision should focus on 1) and ignore 2) unless it is going to cause a long term problem for the company – on that latter point, I would just remind everyone that the tobacco companies are still doing well and their product has killed more people than all of the wars in history combined.

Let’s look at the numbers:

Profit margin 9.55%

Return on Equity 20.01%

PE Ratio of 6.12

Low leverage – excluding intangibles 34.44%

5 year compound earnings growth rate 20.16%

We have consistent earnings growth, a simple, understandable business model and clear performance through different economic cycles, especially recession. Given the Brexit vote in June, that latter point could be key over the next few years if things get tough.

Warren Buffett, and before him Benjamin Graham speak about the concept of a margin of safety. If I take the present value of the next 10 years cashflows using this years net income as a base I get an equivalent fair value share price of £4.33. At today’s closing price of £2.802 that gives me a margin of safety of 54.6%. If I take the last 4 years net income and average them to get my base figure for projecting forward (building in some worse years to be more prudent) I get a fair value price of £3.32 and a margin of safety of 18.4%.

You need a margin of safety because no-one has a crystal ball, and maths can’t make up the difference. So to be clear I don’t actually believe either of the figures above are accurate. They represent my best guess at the range of potential levels that currently appear reasonable. Something could happen tomorrow that will make a nonsense of these assumptions, but currently they are the best I can make. The fact that there is only one year in the previous 10 that Sports Direct revenue has been more than 5% down on the previous year also gives me comfort (but not certainty ) that future performance will continue to be steady on the balance sheet if not in the boardroom.

My personal view is therefore that Sports Direct is worth a long term investment, and I do hold these shares. However, this is not investment advice so do your own research and I would be happy to hear from anyone with the same, similar or completely different views to my own.





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