Will Go Outdoors acquisition power JD Sports Fashion plc to new highs?

Shares of JD Sports Fashion (LSE: JD) sprinted 3% higher this morning, after the sports and outdoor retailer announced a £112.3m deal to acquire competing group Go Outdoors.

JD Sports has used a mixture of acquisitions and organic growth to double sales since 2011. The group’s earnings per share have doubled since 2014. However, JD Sports shares are already worth 250% more than they were two years ago, and some investors have started to take profits on this top performer.

Should you sell after today’s news, or is Go Outdoors likely to deliver a further step increase in profits for JD Sports?

Backing a proven winner

JD Sports shares currently trade on 20 times forecast earnings, with a forecast dividend yield of just 0.5%. That certainly isn’t cheap. But consensus earnings forecasts for the company have risen by 47% over the last twelve months. This is the main reason why the shares have continued to climb.

I believe that the Go Outdoors acquisition makes good sense, and could help deliver a further round of gains for JD Sports shareholders.

Expanding reach

According to today’s announcement, most Go Outdoors stores are located on out-of-town retail parks. In contrast, most of JD’s current stores are situated in high street locations. So the new stores shouldn’t steal sales from existing JD locations.

Go Outdoors reported sales of £202m last year. That’s about 10% of JD Sports’ expected sales this year. so  this acquisition is clearly big enough to move the needle on group results.

I also think that the price being paid for Go Outdoors looks reasonable. JD Sports currently trades on a price/sales ratio of 1.6. At £112.3m, today’s acquisition of Go Outdoors has been made at a price/sales ratio of just 0.6.

One reason for this is that Go Outdoors’ operating margin was just 3.0% last year, compared to 7.3% for JD Sports Fashion. However, it’s worth remembering that companies in private ownership often minimise their reported profits, in order to reduce tax liabilities. I’d also expect JD Sports’ greater scale to provide some cost efficiencies.

I expect to see profit margins rise at Go Outdoors over the next year or so. If I’m right, then earnings per share growth could be stronger than expected. If I was a JD Sports shareholder, I would certainly continue to hold after today’s news.

Could this bargain buy double in 2017?

It’s been a terrible year for Sports Direct (LSE: SPD). But contrarian investors often make big profits from buying good companies that are down on their luck.

Does Sports Direct fit this description, or is it just a bad company? I’m not sure. Historically, Sports Direct’s performance was impressive, with high profit margins and strong cash generation. But trading has gone downhill suddenly this year, and it’s not entirely clear to me why.

Sports Direct’s profits are expected to halve this year, with analysts now expecting earnings of just 20p per share. This figure is expected to rise by 9% to 21.7p next year, which puts Sports Direct on a 2017/18 forecast P/E of 14. That doesn’t seem very cheap to me, especially as the group has never paid a dividend.

For me, the jury is still out on Sports Direct. I’d want to see some evidence of a turnaround before I’d consider buying.

Today's top retail buy?

JD Sports Fashion is not the only retail stock that's delivering strong growth. Here at the Motley Fool, our experts have identified a FTSE 250 retailer they believe could triple in value over the next few years.

The company concerned has a famous brand, and an ambitious expansion programme. History suggests significant further gains may be possible. If you're hunting for retail stocks with real growth potential, I'd urge you to take a look.

The good news is that this FREE, no-obligation report is available for immediate download. To receive your copy, simply click here now.

Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.