Question: Big 5 Sporting Goods
You are an analyst for Big 5 Sporting Goods (NASDAQ: BGFV), a sporting goods retailer headquartered in El Segundo, California with 420 stores throughout the West. One of your real estate people tells you that a new opportunity has arisen at the location in Richfield, Utah.
Richfield is a city of 7,520 people in central Utah. Although there are dozens of towns nearby, it is the largest city for 100 miles in any direction and is conveniently located on I-70 a mere 35 miles from its intersection with I-15. Its remoteness, plus its location on major transportation corridors, makes it central Utah's de facto regional capital. According to Roylance Ward, author of Utah: A Guide to the State, Richfield is the "commercial capital of a vast mountain-valley region."
A large competitor, K-Mart, announced on Jan. 20th 2016 that it is closing its location in Richfield as part of a national restructuring. K-Mart's location is superior to Big Five's current location. The owners of the space that K-Mart just vacated have offered to rent the space to Big Five. You are given a 2-year old advertising brochure for the plaza (see Blackboard). The plaza used to house a direct competitor to Big 5 called Hibbett Sports.
Big Five's current location is a stand-alone structure that is 6,500 square feet. This is a bit smaller than Big Five's typical format of 8,000 - 15,000 square feet, and as a result it only has $1.5 million in annual sales. You are currently paying $9/sf per month. The owners of the former K-Mart location are subdividing the K-Mart space and are offering to let you rent either 9,000 or 16,000 square feet in their center for $9/sf per month. If you choose the bigger store, they will give your firm $1 million as an inducement for taking the bigger space.
The sales department gives you the following information:
Expected sales in 9,000 square foot at K-Mart location: $2.25 million per year
Expected sales in 16,000 square foot at K-Mart location: 3.2 million per yaer
Cost of Goods Sold as a percent of Sales: 35%
Store Operating Expenses: $300,000 per year per location
Inventory Turnover (Current): 80 days
The finance department gives you the following information:
WACC: 13%
Growth Rate of FCF: 2%
Marginal Tax Rate: 30%
Average Tax Rate: 21%
Also, the warehouse department is experimenting with a new inventory system. It could reduce the inventory turnover to as low as 20 days. If successful, it could be implemented company-wide within 6 months.
There is a clause in your current lease that allows you to close the store with a 6-month notice. You estimate it will take 6 months to open the new store when signing a lease, so you should be to seamlessly transition from one store to the next without paying rent at both locations. You estimate it will cost $400,000 to open the new store and move your inventory to the new store.
You think you can use this offer from the owners of the former K-Mart location as leverage to reduce your current rent at your current location to $7/sf per month (note - this negotiating leverage only applies to your current location).
Assignment: Write a formal report summarizing your findings.The report should contain an executive summary (roughly 1/2 page, single spaced), and any appendices you feel are necessary. The audience is a senior vice president at Big 5, and assume that you are an analyst working for Big 5). The report should answer the following questions:
1) Which option should you choose? (Hint - value the store's ongoing operations as a perpetuity)
2) How will the new inventory system impact your recommendation?