Image source: Britvic (copyright Evan Doherty)
A while ago, JD Sports (LSE: JD) seemed like a classic shared value to me. It was selling for just over a pound a share despite the company's obvious strengths, which ranged from a comfortable cash position on its balance sheet to a well-known brand in multiple markets around the world.
Lately, the JD Sports share price has been on the rise. It now costs around £1.32. But despite the recent bullish momentum, the share price is only 8% higher than it was five years ago, despite the explosive growth the company has achieved during that period.
So while it may be less obvious than it was a couple of months ago when the price was lower, could it still be a valuable stock for a long-term investor like me?
Huge cash generation potential
I think the answer is yes. That explains why I have been buying shares for the past year and have no plans to sell my stake.
At first glance, JD Sports may not seem like a great value holding. After all, its price-to-earnings ratio of 35 isn't cheap. In fact, that seems high. It's much higher than you would normally consider paying for a stock, even one in the FTSE 100 with a track record like the one JD Sports has.
But that's where understanding how to read a company's accounts comes in handy. Those profits are after-tax profits. If we look at the accounts for the most recent full year, they amounted to £227m. But if we look further up the profit and loss statement, operating profits were over £500m.
Tomorrow (May 31), the company will release its final results for last year. It has guided the City to expect pre-tax profits and adjusted items in the range of £915 million to £935 million.
The company is a huge cash generator. It is also consistently profitable; However, there is a large gap between their reported earnings after taxes and their earnings before taxes and adjustments. What's going on?
Investment in growth
In short, JD Sports is spending. Lots.
It is opening hundreds of new physical stores annually, expanding its already considerable global presence. That risks stretching management too thin, but could add scale.
It is also acquiring rivals to help strengthen its own footprint. Last month, for example, he announced the proposed acquisition of the American competitor. Hibbett.
That kind of spending can help JD Sports play to its strengths on a bigger stage. But it also explains why I see JD as a shared value.
The retailer could, if it wanted, turn off those spending spigots in short order and let a larger percentage of its large operating profits trickle down to the bottom line. Doing so could slow growth, but in my view the underlying business is strong and could continue without further growth.
I think the long-term value of JD Sports is higher than the current share price suggests, although that's partially obscured for now by its aggressive and expensive expansion.
Making a mistake is a potential risk. If the Hibbett acquisition does not generate the expected benefits, for example, it could prove to be a costly mistake.
Time will tell, but I still own the stock and am optimistic about the outlook.
