Europeans seeking to distract themselves from a constant barrage of gloomy economic news may be finding solace in sports. Or so it would appear from the explosive growth of sporting apparel and equipment retailer Sports Direct International Plc (SPD LN). In the past five years, despite tough economic conditions, SPD LN has registered a stellar 11.1% compounded annual growth rate (CAGR).
But investors must now determine if these earnings are sustainable going forward. The StarMine Earnings Quality (EQ) model indicates the answer is yes. The company’s score of 97 out of 100 on this measure places it firmly in the top decile of companies in the region. Let’s look at a couple reasons why the stock ranks so highly.
First, Sports Direct has worked down its inventory levels. In the fiscal year ended in April, inventory days were at their lowest level in seven years (see chart). In general, lower inventory levels are a positive factor, often representing better working capital management. A decline in inventory frees up cash and reduces the risk of obsolescence. In addition, inventory represents an important accrual item, and StarMine’s research has found that companies with low accruals tend to outperform in the future.
SPD LN: INVENTORY DAYS
Source: Thomson ONE / StarMine
However, inventory is just one of many accrual items. Let’s look at them in total in this next chart, which shows changes in operating accruals (gold) compared to revenue growth (blue). When accruals are growing faster than revenue it’s a negative factor, showing an increase in non-cash sources of income.
Source: Thomson ONE / StarMine
Earnings are more sustainable when backed by actual cash, not accruals. Here, we see the opposite, with accruals declining and revenue increasing. From an earnings quality perspective, that’s a good thing. Over the past three years, operating accruals have declined on an annual change basis, while revenue growth continued.
While the company saw a revenue boost from the World Cup, which might have been considered just a temporary positive, it offset post-World Cup lost revenue with new product lines. In addition, another spurt in earnings is likely with the Olympics and Euro Cup soccer around the corner in 2012, making it well positioned to sustain earnings into the future.
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