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Attractive demographics among its customers and a spate of dividend payments to sponsors suggest that recreational gear sellers are primed for a wave of dealmaking.

by Bob O'Brien

What do retailers of outdoor recreational products have in common with restaurants?  For one thing, both categories cater to the same attractive demographics. Think of the customers at Shake Shack Inc. (SHAK) or Zoe's Kitchen Inc. (ZOES). Their relatively refined palates attuned to healthy fare suggest they might also be cyclists or paddleboarders.

And like Shake Shack, partly backed by Leonard Greene & Partners LP, and El Pollo Loco Holdings Inc. (LOCO), sponsored by Trimaran Capital Partners, several recreational products retailers, including Academy Sports & Outdoors and Sports Chalet Inc., as well as Camping World Inc., are currently in the hands of private equity firms.

"This is not a sector that's an outlier, in terms of transactional activity," Bruce Cohen, senior partner leading the retail private equity and strategy practice at global consultancy Kurt Salmon, said in an interview. Cohen noted that transactional activity in the recreational products sector has picked up over the second quarter of the year. "There are consumer tailwinds behind the growth of these companies."

On July 1, TSG Consumer Partners LLC, an investor in consumer brands with $3 billion in equity capital under management, announced that it bought Backcountry.com LLC, an online retailer of outdoor gear and apparel, from Liberty Interactive Corp. for undisclosed terms.

"I think what you'll see in the next six months is some more activity on the part of private equity, as well as other buyers," said John Siegler, managing director at Cascadia Capital, an investment bank where he serves as co-head of the consumer and retail practice.

The open question is whether PE firms will be net buyers, like TSG's deal for Backcountry.com, or Versa Capital Management LLC, whose Vestis Retail Group LLC, bought Eastern Mountain Sports, a retailer of athletic apparel and footwear, in January 2013. Or will PE be net sellers? Examples of the latter include Sportsman's Warehouse Holdings Inc. (SPWH), which was taken public in an initial public offering in April last year by Seidler Equity Partners LP.

One prospective signal that some PE-backed recreational products retailers might be readying some transformative event -- a sale, either to a strategic or another financial buyer, or an IPO -- has been the spate of debt raising that some prominent names in the sector have conducted to fund dividend payments to shareholders.

For instance, in mid-June, Academy Sports & Outdoors, a Katy, Texas, sporting goods retailer, priced a $1.85 billion debt issue that included a $200 million dividend recapitalization to benefit its shareholder, KKR & Co. LP (KKR).

In May of this year, Camping World, the retailer of RVs and accessories, priced a $95 million add-on to its credit facility to be paid to its owner, Good Sam Enterprises, a loyalty club program for camping enthusiasts, which is, in turn, owned by private equity investor Stephen Adams. Camping World and Good Sam are run by the companies' CEO, Marcus Lemonis, the so-called king of the buyout, who is also known as the host of the CNBC television program, "The Profit."

Neither Academy Sports nor Camping World responded to requests for comment.

"In some instances, these are red flags," said Paul Swinand, an analyst at Morningstar, of the dividend recapitalizations. Of course, it's not a perfect bellwether, as Swinand noted, inasmuch as private equity portfolio companies frequently remunerate their sponsors in the form of dividends, and not always with the consideration of selling out of their position.

Bass Pro Group, the owner and operator of Bass Pro Shops, one of the largest national retailers of marine equipment, fishing and hunting gear and other outdoor sporting equipment and apparel, raised a $300 million dividend as part of a debt refinancing in May of this year. And Bass, largely family owned by founder John Morris, is not considered by experts as a likely seller of its assets. In December of last year, Bass reached an agreement to become a buyer of a financially sponsored asset, dealing for Fishing Holdings Inc., the maker of Ranger boats and other boating brands. The seller was Platinum Equity Group, which bought the brands out of bankruptcy in 2010.

Platinum's nearly five-year ownership of Fishing Holdings, though, does underscore that some PE-backed assets have been in financial sponsors' hands for a relatively long time by PE time horizons. Next month will mark the four-year anniversary of KKR's purchase of Academy, for instance.

And then there's Sports Authority Inc., which has been a portfolio company of  Los Angeles PE firm Leonard Green & Partners since January 2006, when the firm executed a $1.3 billion leveraged buyout of the sporting goods retailer. The $37.35 per share that the deal was done for represented a more than 20% premium at the time, valuing the chain at about 7 to 7.5 times Ebitda.

But Sports Authority's owners haven't been able to get the chain to flourish in the nine years since, despite, as Swinand characterized it, "Leonard Greene is no slouch on retail." Even changes in upper management haven't effected the kind of turnaround that would, arguably, ready the sporting goods retailer to be brought to market. Meaning the gulf between Sports Authority and Shake Shack remains wide.

There have been some instances of deliberation in the recreational products retailing sector. Sports Chalet, for instance, announced in February 2009 that it was exploring its strategic options. It wasn't until July 2014 that Versa Capital-backed Vestis said it would acquire the business to go along with its Eastern Mountain operation.

Of course, the white-hot specialty restaurant sector, where public valuations have doubled and even tripled shortly after IPOs, differs in important respects from the recreational gear space. For one thing, the growth projections for the two retailing differ greatly. Credit analysts anticipate that sporting goods sales will increase at about the rate of the GDP, or just 2% or 3% a year.  Sales for the fast-casual restaurant sector -- the group that would include successful recent IPOs such as Shake Shack -- increased 11% in 2014, according to a report from market research firm Technomic.

There's also a rapidity factor. The average consumer isn't going to buy another bicycle, fly-fishing rod or set of skis nearly as often as that consumer can indulge in another hamburger (especially if it's a "good-for-you" burger). Nevertheless, both categories are, to some extent, reflections of the lofty equities market, not to mention the ever-accommodating credit market. Said Kurt Salmon's Cohen, "With valuations where they are, I'd expect to see additional activity. And you'd have to expect that the PE firms that have these retailers in their portfolios are looking hard at liquidity options."

And recreational products makers probably have more avenues to monetize those assets than restaurants had. For as hot as restaurant names have been the last year, they've achieved their notoriety solely by going public. Experts said that's because there aren't really strategic buyers for those brands. A Burger King, for instance, can't deal for a Shake Shack, because the culture clash would be titanic. Chipotle Mexican Grill Inc. (CMG), for instance, only became a much-copied hit after it was spun out of McDonald's Corp. (MCD).

On the other hand, big national sporting goods chains can sculpt themselves as strategic buyers. "The brick-and-mortar retailers need to be more facile with their internet models," Cascadia's Siegler said. That's especially so because, unlike restaurants, sporting goods chains are not only battling each other, they're also competing with Amazon.com Inc. (AMZN) and Wal-Mart Stores Inc. (WMT).

The existing recreational products retailers aren't necessarily as fully stocked as they might want to be. Even a huge player like Dick's Sporting Goods Inc. (DKS) has some holes in its offerings, as Morningstar's Swinand noted. Dick's boasts that it has about 80% of the hunting and fishing products that vendors offer but isn't very strong in ancillary categories like bedding and outdoor lighting.

That doesn't mean natural marriages are out there among existing players. Big national players like Bass Pro Shops or Cabela's Inc. (CAB)  offer a unique shopping experience. Bass, for instance, goes mega: the brand recently renovated a one-time professional basketball arena in Memphis and turned it into a store. Cabela's outlets have been known to be among the biggest tourist attractions in some of the Midwestern states that it operates in.

"Cabela's or Bass Pro have different impacts on their customers," Cohen said. "When you go into one of these stores, and you're shopping, say, for a fly rod, you, the customer, are looking for an experience.

"That's very different than going into the local sporting goods store with 3,000 to 5,000 square feet and buying a pair of basketball shoes," he added.

And some of those smaller spaces, whether a Sports Authority or Academy outlet, can be a little, well, shopworn. One of the raps against PE ownership of retailers, as Swinand noted, is that "you don't do a big refresh on the PE watch."

Hunting and fishing retail chain Cabela's (CAB) reported 4th quarter earnings this morning. Comparable profits fell from $1.32 per share last year to $1.11 this holiday period on what the company is calling "Higher Advertising and Promotional Spend".

Increased marketing costs may be part of the story, but that doesn't explain the 5.5% drop in same store sales. Cabela's pulls in more than a third of its revenue during the holiday quarter, which makes this miss mildly more painful.

Contributing analysts on Estimize had expected Cabela's to report $1.35 in earnings per share, which is in-line with Wall Street expectations. The Estimize consensus was slightly lower than the Street's on revenue. When investors' estimates on Estimize are lower than the Wall Street consensus, that often signals investors willing to give the company a bit of a pass. Cabela's earnings were shockingly low, even after considering the lowered expectations.

Cabela's isn't the only one reporting weakness in hunting. Dick's Sporting Goods (DKS) has cited headwinds in hunting as a limiting factor 3 quarters in a row. Dick's is a larger, more diversified, and indirect competitor but the fact that Dick's is singling out hunting as a weak spot not a good sign for the future.

Cabela's CEO Tommy Millner had a more upbeat tone on the earnings call. He believes that the ramped up marketing costs will yield tangible results instantly. Millner said, “We are encouraged that comparable store sales thus far in 2015 have improved.”

"We expect to return to a low-double-digit growth rate in revenue and a high-single to low-double-digit growth rate in diluted earnings per share for full-year 2015 as compared to full-year 2014 non-GAAP diluted earnings per share of $2.88,"

Before this morning's report Wall Street was looking for earnings of $3.50 on the year. Cabela's would need to record growth on pace with the upper end of its guidance to keep up with the Street's consensus. To be exact Cabela's will need to improve earnings by 21.5% to match the Street's current outlook.

Cabela's fiscal year gets off to an easy start. In the first quarter of 2015 the outdoors retailer faces off against a comp which saw earnings per share sink 49% and revenue drop 10% last year. With same store sales up in the first part of the year, Cabela's should be able to get past the next hurdle unless we see another massive increase in 'Higher Advertising and Promotional Spend'.

Cabela's is an analyst favorite with Credit Suisse, Wells Fargo, Suntrust, William Blair and several other research houses having a buy rating (or equivalent) on the stock. As the winter hunting season approaches, it makes sense to look into catalysts that have many of these analysts endorsing the stock.

Shares of Cabela’s are down 12.8 percent in 2014 compared to a 5.5 percent climb for the S&P 500. Part of the drop in share price can be attributed to an increase in short interest to 23.95 percent of the float. This article looks at firearm sales, Cabela’s private brands and an interesting correlation between search engine queries and sales.

Firearm Sales

Hunting equipment, which includes firearms, accessories and archery equipment, made up 48 percent of 2013 sales.

Background checks for the sale of firearms have accelerated in recent months, according to the FBI. The check increased 7.9 percent in June, 9.2 percent in July and 8.9 percent in August. The number of firearm background checks have been historically correlated with gun sales.

Although guns make up a large part of Cabela’s business and the strong uptick in checks suggest strength, shares of Cabela’s have fallen 6.6 percent over the past five months. Continued strength may bode well for investors.

Cabela’s Brand Products

Cabela’s has been putting meaningful effort into expanding its own Cabela’s branded products. With eight to 12 percent higher margins than comparable products, proliferation of Cabela’s private brand could be very lucrative.

In the most recent quarter, private brand penetration increased by 1.8 percent. “The strength of our brand has never been greater, and we are very excited for the innovative new Cabela's branded products we will be offering to our customers throughout the year,” said CEO Thomas Milner at the end of July.

Investors should follow an increased push for house branded camping products. The investment has been described as well received early into the campaign.

Search

(Image from SunTrust research report)

Suntrust notes an interesting correlation between search trends and Cabela’s sales. As can be seen in the chart above, an uptick in search queries for Cabela’s has led an increase in sales in the past. This makes sense as shoppers are likely searching for Cabela’s to make a purchase on or offline.

Because search trends are not as closely followed as other, more traditional metrics, investors noting search trends may have a small edge.