3 Reasons to Avoid SPWH and 1 Stock to Buy Instead

Over the past six months, Sportsman's Warehouse has been a great trade. While the S&P 500 was flat, the stock price has climbed by 35.5% to $3.32 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.

Is now the time to buy Sportsman's Warehouse, or should you be careful about including it in your portfolio? See what our analysts have to say in our full research report, it’s free.

Why Do We Think Sportsman's Warehouse Will Underperform?

We’re happy investors have made money, but we're cautious about Sportsman's Warehouse. Here are three reasons why SPWH doesn't excite us and a stock we'd rather own.

1. Shrinking Same-Store Sales Indicate Waning Demand

Same-store sales is an industry measure of whether revenue is growing at existing stores, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).

Sportsman's Warehouse’s demand has been shrinking over the last two years as its same-store sales have averaged 8.5% annual declines.

2. Operating Losses Sound the Alarms

Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.

Despite the consumer retail industry’s secular decline, unprofitable public companies are few and far between. Unfortunately, Sportsman's Warehouse was one of them over the last two years as its high expenses contributed to an average operating margin of negative 1.4%.

3. Short Cash Runway Exposes Shareholders to Potential Dilution

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Sportsman's Warehouse burned through $6.49 million of cash over the last year, and its $528.4 million of debt exceeds the $3.56 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the Sportsman's Warehouse’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of Sportsman's Warehouse until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

Sportsman's Warehouse doesn’t pass our quality test. With its shares topping the market in recent months, the stock trades at 3.4× forward EV-to-EBITDA (or $3.32 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better stocks to buy right now. Let us point you toward one of our all-time favorite software stocks.

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