On 13 April, JD Sports Fashion (LSE: JD) released its earnings for the year ending January 2021. Considering the economic backdrop, the results weren’t bad at all. Revenue for the year increased 1% while profits fell by less than 9%. Investors reacted positively to the news, with the JD Sports share price closing up 3% for the day.
The bull case
There are many reasons for investors to be optimistic regarding JD Sports. Firstly, the company’s short-term prospects look encouraging. During the pandemic, the firm’s excellent online platform and diverse range of products helped it to weather the difficult conditions. As a result, the company is now in a good position to perform well as the global economy recovers. This is reflected in management’s prediction that profits before tax will grow between 47% and 54% this year.
Secondly, JD Sports also has the potential for long-term growth as it pushes into new markets. This year, the company acquired US footwear and apparel retailers Shoe Palace ($681m) and DTLR Villa ($495m). This added to the company’s US acquisition of Finish Line ($558m) in 2018, helping to significantly increase its presence in the country. These acquisitions could be the key to conquering the US market. If it manages this, the benefits could be huge and the JD Sports share price could explode.
Despite the potential upside, there are risks associated with the company’s growth strategy. Although growing through acquisition can be a quick and effective way to penetrate a new market, it does not guarantee an increase in shareholder value. In fact, if the acquisition is completed at too high a price, shareholder value will be reduced.
JD Sports learnt this lesson with its acquisition of Go Outdoors, for which it paid $112m in 2016. In the years following the transaction, Go Outdoors performed poorly and, last year, it fell into administration. The company has since been restructured but not before JD Sports was forced to recognize a large loss on its income statement. By completing so many large acquisitions and with several more in the pipeline, the company runs the risk of repeating the same mistake it made in 2016.
Although it’s too early to say whether JD Sports paid too much for its recent acquisitions, there are already warning signs that its aggressive growth plans are having negative consequences. Since 2017, return on capital employed has more than halved and operating and net profit margins have steadily trended downwards.
I am also concerned by how the company is funding its growth plans. In February, the firm issued over 58m shares, raising over £450m. This equates to around 6% of total shares outstanding. While this figure isn’t horrendous, it does show the willingness of management to dilute shareholder ownership in order to pursue their growth ambitions. For me, this is worrying and another reason why I am ignoring the JD Sports share price.
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Ollie Henry has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.