12 Reasons Why JD Sports is the King of Trainers

1. 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. April 13, 2017 Authored by: Walter Hin

2. Company name: JD SUMMARY Sports PLC -The share price is up 1,584% in the last decade. (i.e. Invest £10,000 and it turns into £158,400!) Ticker: JD -This share price appreciation didn’t happen in the previous decade (1996- 2006) when the shares lost 8%. Exchange: Main Market (FTSE 250) -JD owns a lot of brands through acquisitions, such as Cloggs, Blacks, Millets, Chausports and Ultimate Outdoors. CEO: Peter Cowgill Current Share Price: 450p/share -The Sportswear increased their real estate from 1.2m Sq. Ft. to 3.5m Sq. Ft. in ten years. MKT. CAP. (£m): £4.37bn -JD been growing its revenue at a compound rate of 12.2% per year. Shares Outstanding: -JD’s operating margins improve from 1.8% during 2004/05 to 8%. 973m 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 -JD bought Blacks Leisure for £20m, when the business was generating £200m in Sales. Free Float: 402m P/E: 24 -It bought Canterbury Europe for £6.5m in 2009 and sold it three years later for £22.7m for 170% return on investment. Dividend Yield: 0.34% Their most recent acquisition was a £112.3m deal for Go Outdoors that makes £3.7m in net profit. Net Cash: £214m Shareholders’ Equity: £552m 1

3. 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 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 2

4. The market valuation of JD in the beginning of 1996 was £134m £134m and ended 2006 with a market value of £139m £139m. In share price terms, you would have lost 8% of your initial capital. 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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 WORKOUT FACT 1: RISING PROFITS AND INCREASING MARGINS 3

5. GRAPH 2 Notice the first three years, JD barely earns £8m per ye £8m per year ar, and operating margins was a small 1.5% 1.5%. From 2007 onwards, other sports retailers begun to unravel. JD started to see improvement in margins and absolute profits. 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 In fact, operating profits is £133m £133m by 2016, a 1,900% 1,900% increase from 2004. WORKOUT FACT WORKOUT FACT 2: 2: JD SPORTS WIDE-RANGING BRANDS COLLECTION 4

6. 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: WORKOUT FACT 3: SUPERME PROFITABILITY RATIOS GRAPH 3 GRAPH 3 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 5

7. 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 WORKOUT 4: JD POSITIVE + INCREASING FREE CASH FLOW GRAPH 4 GRAPH 4 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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. 6

8. WORKOUT FACT 5: WORKOUT FACT 5: GREENBLATT’S Return on Capital GRAPH 5 GRAPH 5 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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 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. 7

9. 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 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. 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 GRAPH 6 GRAPH 6 8

10. 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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 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) 9

11. P.S. P.S. I use current year sales increase vs. previous year capex, to account for time-lag in generating the sales. GRAPH 7 GRAPH 7 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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 WORKOUT FACT 8: JD SPORTS, a CONSERVATIVE DIVIDEND-PAYER 10

12. GRAPH 8 GRAPH 8 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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% (£13.82m/£90.95m) *100 = 15.1% 11

13. WORKOUT FACT 9 WORKOUT FACT 9: JD’s MARKET VALUATION AT RECORD HIGHS GRAPH 9 GRAPH 9 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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. 12

14. WORKOUT FACT 10 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 GRAPH 10 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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 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) 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. 13

15. GRAPH 11 GRAPH 11 This marks a big difference when it struggles to appreciate its market value as 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 CFROI fails to exceed 25% between 2004 and 2006. WORKOUT FACT 12 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 GRAPH 12 14

16. Now, the company is riding on £112m of net cash. 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 15

17. 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: 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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 16

18. 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 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 1

19. 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 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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? What makes this acquisition successful? 2

20. 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: 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 Table 3 3

21. Champion Sports (Holdings) JD Sports bought Champion for €20m. Champion has a turnover of €54m in 2009. Go Outdoors 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. 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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 4

22. 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 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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. 5

23. What have we learned from these acquisitions? JD Sports acquired £657m of sales for £184m 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 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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. 6

24. 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” 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 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. 7

25. My Website: http://walbrockresearch.com/home/ My Twitter: https://twitter.com/Wh_biz32 12 Reasons Why JD Sports is the King of Trainers | 4/13/2017 8