JD: Profit From the Cool Factor

JD Sports is a leading retailer of sports and streetwear footwear and apparel in global markets. It’s best known for its namesake JD, however, it has a roster of niche retail stores under the JD Group that cater to varied customer types across the markets it serves, such as Size? and Footpatrol in the UK, Finish Line and Shoe Palace in the US and Sprinter in continental Europe. JD has been one of London’s best-performing stocks over the last decade, rising nearly 2000% during the ten year period. This has been driven by JD’s flawlessly executed international roll-out, its prudent management and a vast tailwind behind premium athleisure products, as the world relaxes its dress code and fitness trends build momentum. JD reported final results for the year to 31st of January on Tuesday, and it is fair to say, JD has seen a resilient performance indeed. Revenues are very slightly above 2019 levels at £6.16 billion, a result aided by a strong rebound in demand in Q3 and Q4 of 2020. In this article, I want to explore what makes JD’s proposition so special and why I believe it is primed for continued growth for years to come.


In this article, I will be covering the topics below:


Market Dynamics


Before I deep dive into JD’s business model, I want to talk a little about the market JD operates in and the fundamentals of the customer base JD appeals to. JD’s core customer is the 14-25s market. No matter what stage — school, college or university — a momentous driver in a young person’s life is social acceptance (having lived through this age bracket, I can attest to the need of having a cool pair of trainers!). With a low likelihood of being able to afford typical status symbol assets such as expensive cars, watches or houses, the largest purchasable driver of social status for teens is the trainer (or sneaker as they call them stateside) with trend-based clothing coming in a close second.


In terms of product, the majority of JD’s revenues are related to a specific niche called ‘athleisure’. This differs from the wider fashion market, which focuses on either formal or casual fashion; JD’s offering is a blend of sport style clothing and footwear that no one really exercises in. Thus, athleisure differs from sportswear in the fact that its end-use is for everyday lifestyle wear vs sports or exercise. You can think of JD as similar to the automotive industries SUV or 4x4 product lines, which make cars that are very capable of off-road terrain, but in reality, just get used for the school run. This athleisure style is actually growing faster than the wider fashion market and has been for some time. This growth is underpinned by:

  • The desire for comfortable everyday wear

  • Social acceptance of dressed-down styles

  • Increased focus on health and wellness

  • Successful marketing structure — sports players and celebrities in the design process

Contrast this segment with the fortunes of many of the high street brands such as Topshop, Burton and Ted Baker. These brands have faced bankruptcies and general business destruction due to a host of reasons, but one of the most significant is the major headwind in the formalised/smart-casual style that has typically fed profits for these businesses.


JD’s Business Breakdown


JD is a global sports fashion and outdoor equipment retailer. JD’s footprint is now increasingly international, with roughly 41% sales in the UK, 26% sales in Europe, 28% sales in the US and 5% in RoW markets, primarily in Asia. JD’s geographic sales mix has changed quite dramatically in recent years, from primarily being a UK and continental European retailer to the addition of a vast store estate in the US through the acquisition of Finish Line (a US sports fashion retailer) and the subsequent acquisitions of Shoe Palace and DTLR (two additional US sports fashion retailers). JD now has a presence from the East to the West Coast of the US and believes the US to be a key growth driver for the years to come.


JD’s retail offering can be broken down into four specific categories — sports fashion multichannel retail (brick and mortar stores with eCommerce additions), outdoor clothing and equipment, online-only retail websites and JD Gyms.


Sports fashion multichannel retail (Revenue £5.6bn):

  • JD (Global)

  • Size? (UK & Western Europe)

  • Footpatrol (UK & France)

  • Chausport (France)

  • Sprinter (Spain)

  • Aktiesport & Perry Sport (Netherlands)

  • Finish Line (USA)

  • Shoe Palace (USA)

  • DTLR (USA)

  • Scotts (Scotland)

  • Tessuti (Italy)

Outdoor brands UK (Revenue £414m):

  • Blacks

  • Millets

  • Go Outdoors

  • Ultimate Outdoors

  • Tiso

Online only:

  • Mainline menswear


As you can see from above, both the store estate and retail brands under the JD umbrella are numerous. The recent acquisitions of Finish Line, DTLR and Shoe Palace have added roughly 1000 stores to the global store portfolio and show JD's ambition to make the US a key geography.


Recent Results


Digging into the recent results from JD for the full-year period in 2020, there was quite a variation in performance across each geography, driven by the varying lockdown restrictions and the maturity of online presence in each market. In the UK, JD’s largest market, a relatively mature and well managed online website managed to retain around 70% of the prior year sales at first lockdown, followed by strong trading when the UK stores reopened in the summer and a 100% level of online retention in the second lockdown throughout the winter period. Looking to their European market, 60% of sales were retained in Northern European markets such as Germany, France and the Netherlands. However, lockdowns in Spain resulted in only 20% sales retention throughout the lockdown period, as online penetration for Sprinter and Sport Zone brands are less advanced. Looking to North America, JD coined the performance ‘exceptional’ with 75% of sales retained during lockdown periods due to the strength of their online channels, more stores reopening sooner and a significant boost from stimulus packages — which JD noted lifted sales through all channels by 50%. With all geographies combined, revenue for the year managed to just surpass last year at £6.16 billion vs £6.11 billion in 2019.


For me, these results tell the story of a well-diversified business and an effective multichannel strategy. Brick and mortar retail will always be part of the JD proposition, however, strength in online has proved a worthy investment as lockdowns have restricted store openings. Not only this, but the retention rates also have stress-tested JD’s flexibility as a business model. To fulfil 70-75% of orders, which would typically be facilitated from thousands of stores across large geographies through a limited number of websites and distribution channels, is a serious feat and one that proves JD’s mettle.


Factors That Make JD a Quality Business


JD has a fantastic track record for growth and has delivered stellar results over the long term for shareholders. However, I rarely see JD cropping up as a holding in UK or internationally managed funds. I also rarely see JD discussed as a top stock for investors, even though it has delivered an insane share price gain of just under 2000% in the last 10 years. So what is misunderstood about the quality of JD’s business?


The first feature that makes JD a quality business is the cool factor. It may shock you to hear a somewhat sensible investor relying on ‘coolness’ for profits, but there is a method to my madness! If you, like me, have visited a Size? store owned by JD in recent times, you will see an interesting phenomenon. Male shoppers ‘hang’ in the store premises, often for hours, socialising and enjoying the vibe of urban music and the latest products from JD’s edgy store outfit. This is anecdotal, however, I would attest that it is somewhat rare to see a male shopper take time to browse and enjoy the retail experience. JD’s cool factor is propelled by limited-edition footwear releases and by in-depth knowledge of the customer, which ensures that JD and their brands are the essential destinations for urban apparel and footwear. This may sound silly, but bringing it back to the investment case, the cool factor significantly reduces customer acquisition costs and increases customer loyalty, helping both the top and bottom line. The cool factor also goes a long way in enhancing the brand value of key brands such as Adidas and Nike. Brand value is essential to clothing and footwear brands, and the choice of retailer can build or destroy brand equity. Given the choice of showcasing a latest release Nike Air trainer in a flagship JD store versus a retail park Sports Direct (where the product will be discounted and displayed next to a pair of Dunlop/Airwalks) I think we can all agree on the retail partner Nike would choose.


Size?'s flagship store in Carnaby Street, London


The second key feature in the JD proposition is its multichannel strategy. Strength in their online presence, as I discussed earlier, has provided resilience in recent times. However, I believe the real strength is the combination of both channels to an effective degree. JD’s brick and mortar stores show strength on the high street because the proposition adds value. The value is added on both the customer’s behalf — from a fantastic retail experience, good brands and exclusive product releases — and on behalf of their key brand partners (Nike and Adidas), as the products are treated with respect, there is little discounting and the retail estate provides a great place to house new product releases.


Lastly, a key factor for JD’s overall resilience is its product category and market dynamics (which I discussed in the earlier segment) that drives growth and provides reliable demand throughout the business cycle.


The Risk to JD’s Model


The largest challenge JD will continue to face in the coming years will be the shift in key brand’s business models from wholesale to DTC (direct to consumer) business models. By this, I mean the increased focus from key apparel and footwear manufacturers such as Nike, Adidas and Puma to switch their focus from selling to retailers (such as JD and Sports Direct) to a direct selling model to their customers, through online stores and physical retail locations.


I have discussed the reasons for the shift to DTC models here, but for the most part, brands such as Nike and Adidas want more control over the selling process, higher margins by removing the retail chain and to understand their customers better by selling direct. This has also been aided by the reduced comparison burden of switching to online, where customers can view and compare products from different websites very easily, versus needing to compare two products next to each other in a physical retail setting.


JD really has two methods of combating this pressure from the key brands it relies on so much. Firstly by growing scale. I believe the large acquisitions in the US may be partly down to this pressure. By growing scale, JD becomes an ever more meaningful partner to the core brands Nike and Adidas, thus the relationship becomes more equitable. The larger JD gets, the more it will be able to get what it wants — preferential treatment from the key suppliers. If the key brands upset JD at this larger size, JD could potentially deliver a meaningful blow to either brands P&L through removal or deprioritisation of a brand at its key retail sites (though removing a key brand from JD retail locations would be akin to shooting themselves in the foot).


Secondly is the added value factor JD brings to the key brands by choosing JD as a retail partner. Value is primarily added by housing product lines in physical retail sites — as an example, JD just opened a flagship store in Time Square, NY. Showcasing footwear or apparel at high-end locations and trendy stores significantly adds to the brand value that key suppliers wish to build with their customer base. Value is also added by the network effect JD has, where the ‘cool factor’ brings in trend-following customers that like the products on sale, and who thus pay a high margin price.


Either way, JD seems to be excelling in its relationships with key brands, and it frequently manages to get called out as a key retail partner in Nike’s earnings calls.


Growth


Revenue growth at JD has averaged 29.4% over the last 5 years. This has been a mix of both organic and bolt-on acquisitions, but in fairness to JD, it pays a very slim dividend, thus most of the excess capital is put to expanding retail units, or purchasing retail units through acquisitions. JD has a number of growth drivers at its disposal to keep growing for many years to come, for which the main drivers are:

  • Global store expansion — Asia and Latin America are virtually untouched markets for JD. Its Europe expansion target is currently at one store per week.

  • Like-for-like sales growth in current locations — improving the performance of their current retail locations.

  • eCommerce growth — particularly focused on immature eCommerce markets such as Spain.

  • Growth in the athleisure market — resulting in the overall expansion of the product category.

  • Bolt-on acquisitions — funnelling cash flow into acquisitions for further store estate growth.


Financials



A look at JD’s financials helps to show the underlying health of the business. As you can see, the top line has rapidly grown from £1.82bn in 2015 to £6.16 in 2020, at an average growth rate of 27% per annum. Gross margins are typically held at just below 50%, which is very good for a retailer. Operating margins have averaged around 8% over the last five years, and I doubt much margin expansion can be had whilst JD is still prioritising the growth of its retail estate. Whilst operating margins are at the lower end of the typical business I choose to analyse, we have to be mindful that retailers have lower margins than most industries, and underlying profits are typically driven by scale. Even with this being the case, JD’s operating margins are significantly ahead of similar fast-growth fashion retail peers such as Asos and The Hut Group, which both have operating margins of around 4%, and are in line with Boohoo at 8%. As you can see, with the debt to equity ratio remaining around 1, JD has typically been prudent with cash and explored bolt-on acquisitions and used free cash flow for expansion initiatives. However, you can see in 2019 that the ratio rose sharply to 2.49 as the large Finish Line acquisition was accounted for. This has levered JD’s balance sheet to slightly higher levels than the norm. However, judging by the results in 2020, the acquisition looks to have been worth it. JD hasn’t published the full accounts for 2020 yet, so we are unable to see the impact the pandemic has had on the balance sheet, but we do know JD ended the year with a healthy net cash position of £795m at the year-end. Lastly, the key figure of return on capital employed — a great assessment of a company's ability to deploy capital efficiently — shows an average of 28% from 2015-19, whilst significantly declining as the group digests the assets from the Finish Line acquisition.


Summary


In summary, JD’s financials show a business growing scale with modest profit margins. Margin expansion could be on the cards, but as revenues have grown from £3bn to £6bn, margins have fallen from 10% to 7%, showing that increased scale does not necessarily bring improved margins.


In terms of valuation, JD trades at roughly 25 times 2022 earnings estimates, which is a significant discount to sportswear brands Nike and Adidas at 33 and 30 times 2022 earnings estimates respectively. JD is also growing faster than both these peers, and in many respects is more diversified — the risk of one brand going out of fashion is reduced. I think 25 times earnings is a fair price to pay for a business that is as advantaged and that has as strong a growth record as JD.


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The Twenties Trader owns shares in JD.


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