Shares of Foot Locker (NYSE: FL) soared 20% on May 25, after the athletic footwear and apparel retailer’s first-quarter numbers beat analysts’ expectations. Its revenue rose 1.2% year over year (but fell 1.5% on a constant-currency basis) to $2.03 billion, clearing estimates by $70 million. Its comparable-store sales dipped 2.8%.
Its non-GAAP net income slipped 3.3% to $174 million, or $1.45 per share — still beating expectations by $0.20. Those numbers seem unremarkable, but some investors believe that Foot Locker’s business might finally be approaching an inflection point.
Why the bulls are interested in Foot Locker
Foot Locker reduced its store count by 70 year over year to 3,284 locations, and its merchandise inventories declined 5.4% (7.1% on a constant-currency basis) to $1.21 billion.
Foot Locker also secured more premium products during the quarter, which CEO Richard Johnson claims increased the “breadth and depth in the most sought after styles from our key vendors.” Johnson noted that Foot Locker’s strategic partnerships with top footwear brands gave it a “central position in youth culture” — which could generate positive comps growth later this year.
Speaking to CNBC, Susquehanna analyst Sam Poser noted that shoppers who wanted specific items might start at Nike (NYSE: NKE), adidas (NASDAQOTH: ADDYY), or Under Armour‘s websites — but shoppers looking for “the best new stuff” or “the coolest sneakers” still frequented Foot Locker’s stores.
That trend was reflected in the company’s high-single-digit comps growth at Kids Foot Locker and low-single-digit comps growth in its Foot Locker and Eastbay (direct-to-mail) stores in the U.S. Foot Locker also reported higher average selling prices (ASP), units, and revenues in apparel for both genders.
Foot Locker’s stock still looks cheap after its recent rally. Wall Street expects its earnings to rise 9% to $4.48 per share this year, so the stock trades at just 12 times this year’s earnings. Finish Line, which is in the process of being acquired by JD Sports, currently trades at 18 times this year’s earnings.
Why the bears still don’t like Foot Locker
Foot Locker certainly made improvements, but many of its core metrics are still headed in the wrong directions.
Its gross margin fell 110 basis points annually to 32.9%, due to higher markdowns, slower-moving styles, and a deleveraging of its occupancy and buyers’ compensation. Meanwhile, its sales, general, and administrative expenses rose 50 basis points year over year to 19% of sales, due to foreign exchange headwinds, higher investments in expanding its digital ecosystem, rising wages, and legal settlement costs.
Its overall store traffic also slipped by low single digits. Total footwear unit sales also slipped — with a low-single-digit comps decline in men’s and kids’ footwear and a low-double-digit drop in women’s footwear — due to tough comparisons to high sales of Puma‘s Fenty and “select” Adidas products in the prior-year quarter. On the bright side, its ASP for all footwear rose, supported by higher sales of premium products.
Foot Locker’s other banners fared poorly — Foot Action, Champ Sports, Foot Locker Canada, Foot Locker Asia Pacific, Foot Locker Europe, Runners Point, and Sidestep all posted comps declines during the quarter. As a result, its brick-and-mortar stores posted a combined 3.1% comps decline, while its direct-to-consumer (DTC) channel generated flat comps growth.
That’s troubling, because Foot Locker needs its DTC channel to expand to counter first-party rivals like Nike, Adidas, and Under Armour. Piper Jaffray’s latest “Taking Stock With Teens” survey ranked Nike as the top apparel and footwear brand, while Adidas ranked third in both categories.
The survey also ranked Nike as the second most popular shopping website for teens after Amazon — which could spell trouble for Foot Locker’s e-commerce initiatives. Nike also operates over 1,100 brick-and-mortar stores worldwide, and that number has risen for four straight years.
If Nike keeps expanding its retail presence as Foot Locker retreats, the bullish claim that Foot Locker is becoming “cool” again could be crushed by the bearish claim that it’s still a dying middleman.
The key takeaway
Foot Locker’s stock still looks cheap after its recent rally, but I think the bulls are getting ahead of themselves. Foot Locker is showing signs of life, but its comps remain negative, its margins are slipping, and it’s heavily dependent on Nike — which is still poised to become its biggest competitor.
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