QUALIPORT
JJB Sports: Fit For The Qualiport?

By Maynard Paton (TMFMayn)
February 21, 2002

Carburton Street, London -- JJB Sports (LSE: JJB) has a lot of attractive features. It's a market leader with a robust financial record. But the group does exhibit certain operational risks. With the Qualiport already owning shares in three other High Street retail operations, does JJB measure up?

JJB's business

Valued at £970m, JJB is the UK's largest retailer of sports clothing and sports equipment. Founded by Chairman David Whelan in 1971, JJB now operates over 430 stores throughout the country.

Since JJB's flotation in late 1994, the company's shareholders have endured a roller coaster ride. Capitalising on the buoyant demand for sportswear, JJB regularly notched up double-digit like-for-like sales growth during the mid-1990s. However, demand suddenly plateaued in 1998, a year when JJB bought its then larger rival, Sports Division, for £289m. Various logistical problems followed, resulting in like-for-like sales growth suddenly turning negative. During 1998, JJB shares had touched 410p before reaching a 90p nadir.

But JJB -- and its share price -- has since fully recovered from those earlier woes. The Sports Division purchase allowed JJB to make a quantum leap in distancing itself from sector rivals. Increased economies of scale and competitive pricing have allowed JJB to capture additional market share. JJB continues to expand, steadily replacing smaller outlets with larger superstores. Although the number of stores has remained steady at around 430 over the past year, retail floor space has increased by nearly 10%.

Financial history

Here's how JJB has performed financially over the past five years:

Year to 31st January           1997    1998    1999    2000    2001

Turnover (£m)                 130.8   203.6   373.0   614.1   663.3
Operating Profit (£m)          19.8    33.7    46.7    79.0    91.7
Pre-tax profit (£m)            20.3    33.1    41.1    71.0    84.1

Earnings per share (p)          7.2    12.2    13.3    19.8    23.7
Dividend per share (p)          2.2     3.4     4.2     5.0     5.8

Number of stores                167     202     471     436     433
Floor space (000 square ft)     814   1,304   3,020   3,205   3,433

(all figures adjusted for goodwill)

The Sports Division purchase brought in an extra £320m of annualised sales for JJB. To fund the purchase, JJB took on £170m of loan notes and £150m of debt. During the year to January 2001, gross interest cover remained a reasonably comfortable 5.5. Apart from Sports Division, the company has made no other acquisitions, and the only exceptional items incurred during the company's quoted history were various costs  (totalling just £1.3m) associated with the purchase. But it's worth noting JJB's present operating margin, at 13.8%, still remains below the 16.5% peak level achieved prior to buying Sports Division.

Cash flow and return on equity

To 31st January              1997     1998    1999    2000    2001 

Operating Profit (£m)        19.8     33.7    46.7    79.0    91.7


Change in                                                         
working capital (£m)          0.5     (5.2)   (5.6)  (13.3)   (2.8)      

Depreciation (£m)             3.2      4.6     9.1    13.1    14.9

Capital expenditure (£m)    (19.0)   (15.6)  (26.4)  (27.2)  (28.7) 

With the ability to defer supplier payments and collect cash from customers immediately, retailers ought to generate inflows of working capital cash on a regular basis. In this respect, JJB's working capital performance is quite disappointing, especially when compared to the comparative figures at portfolio members Carpetright (LSE: CPR), DFS Furniture (LSE: DFS) and PizzaExpress (LSE: PIZ).

To 31st January              1997     1998    1999    2000    2001

Earnings (£m)                13.0     21.9    28.0    49.1    58.6
Shareholders' Equity (£m)    36.3     53.8   224.1   255.3   299.8 

Return on average equity (%) 40.2     48.6    22.5    20.5    21.1 

Incremental return 
on average equity 97-01 (%)                                   17.3

(all figures adjusted for goodwill) 

Since its 1994 flotation, JJB has achieved an incremental return on equity of around 19%. That's a notable accomplishment, given the Sports Division acquisition immediately hampered equity reinvestment returns.

Summary

JJB has many attractive features. It's a market-leading, simple and straightforward business with a sound financial record. Furthermore, JJB is run by an experienced management team (who collectively own 17% of the company), with the Chairman, Chief Executive and Finance Director all having been in the boardroom for at least the past twelve years.

So, is JJB fit for the Qualiport? No. In short, the company does not measure up to the three other retail businesses (Carpetright, DFS Furniture and PizzaExpress) that are already in the portfolio.

Firstly, there is the question of JJB's competitive advantage. While the group's size and scale give it a pricing edge, JJB is very much reliant on branded product suppliers. Who has the upper hand in the negotiations: JJB or the likes of Nike (NYSE: NKE), Adidas and Reebock? Given the general brand-conscious nature of JJB's customers, I'd say the suppliers have the edge. But whatever you think of JJB's supplier position, it's certainly less attractive than that of Carpetright, DFS and PizzaExpress. These three firms effectively sell own-label goods, and as such, have greater control over their own destiny.

Secondly, there's JJB's expansion into other areas. At the moment, the group operates three "Soccerdomes" and four health clubs. Both have provided encouraging results so far, and a rollout of both formats is expected over time. But whether the long-term returns from these concepts prove as successful as the core retail chain is anybody's guess.

The obvious risk for shareholders from these new concepts is JJB diversifying from its core competency (sports retailing) and into another highly competitive area (sports facility management). Can JJB compete effectively with Holmes Place (LSE: HOL), Fitness First (LSE: FTF) and the myriad of other gym operators? There's a real danger of the JJB management taking its eye off the ball if growing pains occur at the group's fledgling businesses. At least at Carpetright and PizzaExpress, diversions from the core store operation still involve selling carpet and pizzas.

Overall, JJB is certainly a better than average company. But the group does exhibit additional operational risks when set against the three retailers already in the Qualiport. With a tight focus on the very best companies, there's no room for JJB on the portfolio watchlist.

More: JJB Sports discussion board

The author owns shares in Carpetright