Hibbett - an informal stock note

The funds I manage owns roughly five percent of Hibbett - a retailer of street fashion and sporting equipment - and above all - sneakers. Researching this stock turned me down the sneakerhead path.

Normally I do not write up the stocks we own because often we intend to buy more - but in this case we own about five percent of the company which is a smallish position for us - but we are a large shareholder for them.

We do not intend to buy stakes big enough to influence management - and we prefer own stakes that are small enough to sell should we change our mind. So we are unlikely to buy more of the stock.

For this reason I wrote it up - and sent to clients.

The note is of more general interest - so here it is as sent.

The warning here is real though. One reason fund managers do not write up stocks in detail often is that reality has a habit of making people with strong opinions look like idiots. I may look like an idiot here too one day.

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The informal stock note as sent

Hibbett is originally a chain of sporting goods stores in the South of the USA (headquartered in Birmingham Alabama), and mostly in towns too small to have a Dicks Sporting Goods store. The company has been well managed for decades and has over the decades grown and repurchased shares. Between 2001 and 2020 the share count roughly halved and revenue went up five-fold. Even after all this it remained a relatively small business and with a market capitalization below half of a billion dollars.

Along the way it made a small acquisition of City Gear, a highly urban retailer of street clothing targeted at a mostly African American market. They paid $88 million in cash and up to $113 million including earn-outs. For reasons explained below this was an astonishingly good acquisition.  

Our interest in Hibbett came about in an unusual way. In 2014 Nike was trading at 3.5 times sales, Adidas was trading at 0.8 times sales and Puma was trading at 0.5 times sales. These companies look like they are in the same business (sneakers) and valuation and profitability differences like this attract our eye. 

We were visiting Germany and Adidas and Puma are both headquartered in Herzogenaurach, a small German town outside Nuremberg. The companies are located together because they were founded by brothers.

We learned a lot about the business. 

At the risk of extreme simplification, the marketing of athletics shoes and street shoes is done by getting the shoes onto the feet of the right influencer – and then having people copy that influencer and then people copy people etc. The influencers of choice are mostly sports stars but musicians (especially hip-hop and rap) and Instagram influencers (like the Kardashians) matter.

When we went to Herzogenaurach Puma was a mess. The most important sports star they had contracted was Usain Bolt. His likeness, ten metres high, towered over us as we walked through their building. Usain Bolt is of course one of the greatest athletes to ever put on spikes, and he exudes Jamaican cool. He should be a great ambassador for the shoes. And he probably was. But there is a problem – he came out once every four years, ran for less than ten seconds and that was so fast that you could barely see him. Running a 9.6 second 100 metres does not make it easy to identify the shoes.

By contrast Lionel Messi (sponsored by Adidas) is a great shoe ambassador. He is also cool and he comes out every weekend. Moreover, what he does looks achievable even though it is clearly not. Kids want to be Lionel Messi. 

Adidas were clear about what they were good at and what they were not. We will never forget what they said.

They said that in Europe football (soccer) was the entry ticket to the shoe industry and they were level-pegging Nike both in sales and in access to influencers. There were certain football players who were more important in shoe marketing than others. Paul Pogba was particularly important as young people thought he was hot. [The Adidas advertisement “I am here to create” is a true gem showing how Adidas wanted to link Paul Pogba to the shoes a kid might wear.]

Then they told us their story about why Nike was beating them. They said that there is a path in footwear in the world – which is from American Basketball to African American kids to white American kids to Chinese kids. The core sport in their business wasn’t European football, it was American basketball.

So, we asked them the obvious question – if we gave you five billion dollars and said to go out and find all the young kids that will one day be NBA stars, and their coaches, and their parents, and the college athletes and start sponsoring them all could you solve this problem?

They said no. And that they had blown several billion dollars trying.

They laid out an alternative strategy. They said that they could get to African American and to white children through their music. And they laid out a proof of this. They told us that they were always stronger in the music business than Nike going back to the days of RunDMC and My Adidas. They said  they were much stronger than Nike in shoes designed to be worn without laces. They told us (and we have since checked) that if you see kids in Beijing wearing sneakers designed to be worn without laces they are most likely wearing Adidas.

Being terminally unhip, we did not get the cultural reference. Hip-hop stars wear shoes without laces as a nod to prison culture where laces are taken out to prevent inmates hanging themselves. American kids copy the musicians, Chinese kids copy the American kids.

Here is RunDMC wearing Adidas Superstar sneakers without laces:

Adidas told us that they were going to go after the American market through their music.

This was before they signed Kanye West to design for them and before the mega-hit that was Yeezy sneakers. It was well before Kanye decided to go all “mad artiste” and before he tweeted he was “going death con 3 On JEWISH PEOPLE”. It was before Rolling Stone magazine could write an article about how long Kanye had admired Hitler. 

That said – before it ended in recriminations – the Kanye partnership sold a lot of shoes – including to Chinese kids who have never listened to Kanye’s classic “My Beautiful Dark Twisted Fantasy”. 

Nike of change of strategy

Fast forward a few years and Nike has had a change of strategy that was an Exocet to shoe industry retailers. Nike (who do not sell on Amazon) decided (accurately) that they had the hot product and wanted to drive sales through their own (mostly online) channels. They wanted to capture the retail margin.

Nike used to have 30,000 wholesale arrangements (retailers who sold their product). They cut this number sharply, down to 3000 and told people they were going to 1800. Small shoe retailers lost their core brand. Many failed.

Further they had a spat where they sharply reduced support to the giant of sneaker retailing (Foot Locker). The shoe retailers traded down to four times earnings. Consensus was that most would fail – and that Footlocker was in a very difficult position if not complete toast.

Hibbett traded to sub five times earnings too. We bought quite a lot. Our logic was simple. Hibbett owned City Gear and City Gear was a core retailer to a core demographic and Nike was not going to reduce support to Hibbett like they would to Foot Locker.

This was a non-consensus thesis. Foot Locker is long-running super-champion of the sneaker retailing industry. Hibbett by contrast is an afterthought. The Wall Street (correct) view is that most of the time you are better off owning the dominant player in any industry. Small players have worse economics.

In this case we thought (and still think) that Footlocker is long-term problematic and Hibbett is very well positioned.

But for that we need to describe City Gear. 

The typical City Gear store is in a strip mall with very low rent (typically say $40 thousand per annum) in a part of town where the population is 90 percent African American. An example we visited was on Gallatin Pike, Nashville. This store is pictured below.

As you can see the store had bars obscuring the window displays and other things to stop it being robbed, but inside it was a well-presented street fashion store full of brands that were unfamiliar to us. The brands however fit the story (for instance Billionaire Boys Club and Icecream do clothes associated with the musician Pharell Williams). The clientele was entirely African American so when us white guys came in it was thought we were looking for trendy sneakers you could not buy elsewhere. 

We bought the sneakers and chatted to the sales staff about the company, the culture, why they worked there, the music played in the store and all the things that they liked and disliked about City Gear. This store was – from the perspective of the Adidas management we had spoken to years prior – a dream. It was exactly the market Adidas had craved.

We asked some customers why they did not buy the sneakers online. The answer varied from location to location – but we were often told that they would be stolen. They would buy them online if they could pick them up in the shop (which they now can).

This was a comment as much on the sneakers as the neighborhood. The sneakers were hot and were a target of theft. There have been multiple robberies at City Gear stores for the sneakers – and in the worst case a store manager was murdered.

At about 10.30 AM on a Saturday a long queue formed outside the Nashville store. There was a sneaker drop – some limited-edition shoes from Nike. Each store had its own Instagram account and they advertised what they were getting in – and queues formed to buy it. 

We thought there was no way that Nike was going to abandon City Gear. Indeed, we thought it much better than that because Nike was busy closing all the competition. You could no longer buy Nike sneakers anywhere within three miles except at City Gear. There was nowhere that had a range commensurate with City Gear. 

The market thought Nike was going to kill Hibbett/City Gear. We thought that Nike was going to kill their competition. This disconnect was why we bought the stock.

Management were excellent too. The company had effectively been taken over by City Gear management. There are only 200 City Gear stores and about 900 Hibbett stores and the Hibbett stores were becoming cool.

Around Birmingham for instance (and presumably over much of the rest of the country) they were turning Hibbett from a sporting good company to a street gear company. They still sold cleats for the football season – but they occupied less than a metre of shelf space. The shops were becoming fashion, more specifically African American fashion with a slight lag. 

We met a regional manager, a thirty something African American woman who had started as an entry level employee at City Gear and was now in charge of 180 Hibbett stores. She was street smart and sassy, and way more on trend than we will ever be. 

And it showed too. In the sneaker world City Gear shops have the best stock. They had oneoff drops of retro Jordans for instance. Hibbett stock wasn’t quite as on-trend – but it was darn good. And Foot Locker was boring. You go to Foot Locker to buy Nike Monarchs which are famously the “dad shoe”. If you want to know what Monarchs are you can’t go past the Team Monarch Instagram page (which is actually run by Nike and doesn’t shy from how uncool this stuff is). 

The business is working out. Nike has several times called Hibbett out as an important partner. We asked them once why they thought Hibbett was such an important partner and they pointed to the “urban market”. This is odd because Hibbett is largely a small-town and rural brand – but then of course “urban” is code for “African American” and it becomes clear to us that they value City Gear for the reasons we do.

In the last quarterly conference call (a call where Nike guided sales down) Nike labelled Dicks, JD Sports and Hibbett as their important North American partners. They did not mention Foot Locker. And that is deeply confirmatory because Dicks is huge ($12.7 billion in sales). Foot Locker (who are on the outer) is even larger in shoes. Hibbett is less than 10 percent as large in shoes – but is mentioned by name.

We also (randomly) met a Nike executive on the train from Amsterdam to Paris. His responsibility was small distributors in a largish part of Europe. His remit was clear – he was to kill any retailer who was not additive to Nike’s brand – and he was to shower with love a retailer who was additive to the brand. He could organize one-off drops of rare shoes for a special retailer. What he wanted was a retailer that approached important and style-setting niche markets – and his example would be say a skateboard shop that ran skateboard lessons for both elite skaters and 15-year-old girls. 

Where we can be wrong

It is worth thinking where we can be wrong. The most obvious place is that we have bought a sneaker retailer at the height of sneaker culture and maybe we will look back and wonder why people obsessed over one-off drops of unusual Dunk SBs cobranded with the Seattle group Skate like a Girl.

If we come back in 15 years and sneakers are not important in the culture, we will not make money.

Nike guided down sales in the last quarter. Maybe this slight hiccup in sneaker volumes is a sign that the future will be far less rosy.

The second way we can be wrong is Nike and Adidas (the most important brands) do an end-run around retailers. For reasons we explained above we think this is less likely for Hibbett. We also note Adidas and other shoe retailers would crave the space at Hibbett (far more so than they might crave space in at Foot Locker).

The third risk is that Nike (especially) with its exceptional power could use that power to squeeze Hibbett margins to the benefit of Nike. Hibbett margins (as shown in the valuation comments below) have been lower in the past. 

We think this risk is low. Nike has been destocking the competitors – and that has driven Hibbett margins up. We have heard (more than once) that the path of Nike management is to shower in love retailers who are additive to their brand and kill retailers who are not. We think Hibbett/City Gear is additive to Nike – and crushing their profitability is not showering them in love.

The fourth way we could be wrong is that management changes for the worse or becomes venal. One jarring thing about management is that the senior management were entirely white and mostly came to Hibbett from Autozone via their stint as managers/investors in City Gear. The middle management were almost entirely African American, mixed race or Hispanic.

If you want to motivate your best staff you have to show them that there is a way to progress – maybe to the very top. That was not obviously visible.

That said – the middle management we met were very good – and we figure the company should be able to promote from within. We think and hope they intend to. 

Some valuation metrics

It is a Bronte view that a stock note (for a long) should be 15 pages on the business (in this case only 5), one page on management and one sentence on valuation. We are more detailed here.

Here are the last ten years earnings for Hibbett (courtesy of Capital IQ). 

A decent part of the profits went to buying back shares – so I have included a share count. 

Note the margin was typically (up to 2016) comfortably double-digit. That margin was not sustained. They were a sporting good shop in small towns selling baseball bats and mitts in competition with Amazon. This was a losing proposition.

The great purchase of City Gear came with some restructuring expenses – but sales took off and have remained elevated. Margins are typically about 9 percent.

If we are right and the City Gear shift was the reason for the improvement and that reason is sustained, then the stock should be fine. Earnings should be above $8 per share and will increase over time. The stock is – at writing – about $70. At our best purchase it was below $40. This stock could go very right.

But we could be wrong. This might be another internet challenged retailer and this could all be driven by “peak sneaker”. In that case the margin collapse in 2018 and 2019 is a harbinger of bad things to come. We doubt it though. There is no commensurate expansion in sales and margin at Footlocker. We think that City Gear – and Hibbett – really is different.