A little while back, JD Sports (LSE: JD) looked like a classic value share to me. It was selling for little more than a pound a share despite the company’s obvious strengths, ranging from a comfortable cash position on its balance sheet to a well-known brand in multiple markets worldwide.
Lately, the JD Sports share price has been moving upwards. It is now around £1.32. But, despite the recent upwards momentum, the share price is just 8% higher than what it was five years ago despite the explosive growth the company has delivered during that period.
So, even though it may be less obvious than it was a couple of months ago when the price was lower, could this still be a value share for a long-term investor like myself?
Huge cash generation potential
I think the answer is yes. That explains why I have been buying the share over the past year and have no plans to sell my holding.
At first glance, JD Sports may not seem like much of a value share. After all, its price-to-earnings ratio of 35 is not cheap. In fact, that looks high. It is much higher than I would normally consider paying for a share, even one in the FTSE 100 with a track record like JD Sports has.
But that is where understanding how to read a company’s accounts comes in handy. Those earnings are profits after tax. Looking at the most recent full year’s accounts, those came in at £227m. But looking higher up the profit and loss statement, operating earnings topped half a billion pounds.
Tomorrow (31 May), the company will unveil its final results for last year. It has guided the City to expect profit before tax and adjusted Items in the range of £915—£935m.
The company is a massive cash generator. It is also consistently profitable – yet there is a large gap between its reported earnings after tax and its profit before tax and adjustments. What is going on?
Investment in growth
In short, JD Sports is spending. Lots.
It is opening hundreds of new physical stores annually, expanding its already sizeable global presence. That risks stretching management too thin, but it could add scale.
It is also acquiring rivals to help strengthen its own footprint. Last month, for example, it announced the proposed takeover of US competitor Hibbett.
That sort of spending can help JD Sports play to its strengths on a bigger stage. But it also explains why I see JD as a value share.
The retailer could, if it chose to, turn off those spending taps in short order and let a larger percentage of its large operating earnings filter down to the bottom line. Doing so might put the brakes on growth, but the underlying business is strong and could power on without further growth, in my view.
I believe the long-term value of JD Sports is higher than suggested by the current share price, although that is partly obscured for now by its aggressive and costly expansion.
Getting that wrong is one potential risk. If the Hibbett acquisition does not deliver the expected benefits, for example, it could turn out to be a costly mistake.
Time will tell – but I continue to own the shares and have optimism about the outlook.
