FINL: Credibility Does Not Care About Valuation

Takeaway: The last thing that FINL needed was another knock to its credibility. That's what it got, and we can't identify near term redemption.

Our view on FINL following this morning’s results and call remain unchanged. We think management has a credibility issue and in the absence of any substantive catalysts believe the stock will be range-bound over the near term.

 

A few thoughts to consider:

 

  • Tarnished Management Credibility: In addition to a poorly timed (and tested) e-commerce platform transition just before the holiday selling season, management has also been slow to respond to the industry mix shift in footwear from running to basketball resulting in more aggressive promotional activity, which is expected to continue through 4Q. FINL is in “show-me-mode” for the time being. Recall that they initially lost credibility after jumping head first into ‘2012 as an investment year’ back in the spring of 2012. The latest debacle does not help.
  • The Play Here is Long FL: The clear call out of the FINL quarter is confirmation of category divergence between running (decelerating) and basketball (reaccelerating). With FINL over-indexed to running and the trend running away from them (pun intended), we think FL is the clear play here.

 

FL is not immune by any means as it also carries running product, but we expect over-indexing to basketball to drive meaningful outperformance relative to FINL and industry. During the quarter, basketball was up mid-teens while running was down –MSD at FINL. While FL has underperformed in sympathy with the group recently, we expect a near-term rebound reflecting a more robust product mix and underlying business performance. Our biggest concern with Foot Locker is that FINL gets to the point of irrationality with its promotional cadence for a protracted time period. We think that the vendors would have little patience for this, but such pressure from the brands will last only so long.

  • NKE Considerations: NKE is also one of our top long ideas. With much of the basketball success attributed to Nike product lines, we expect continued success for the brand in 2013 in a case of the tail wagging the dog.

 

It was highlighted that consumers are becoming more sensitive to price at the higher-end such as NKE’s Air Force Max. As expected given the timing of increases last year, ASPs came in up +7.8% for the quarter and growth is expected to decelerate to up +MSD in 4Q. While we expect this trend to weigh on the rate of growth in athletic footwear over the coming year, it will have a greater impact on the footwear retailers (FINL and FL) who will be forced to pass it forward more than on the brands themselves. Our sense is that FINL was not talking to the investment community when it made the comment about consumer price sensitivity – it was talking to Nike. They are attempting to negotiate price via the quarterly conference call.

  • Macy’s Deal: Despite the e-commerce interruption, there appears to be little changed regarding the timing or structure of deal as a result. While most likely unrelated, the Macy’s pilot stores will be rolled out in Feb-Mar versus earlier plans to rollout in Dec-Jan. The rest of the store rollouts will start in April as originally planned.

 

 

All in, despite FINL trading at an attractive valuation, the absence of positive catalysts over the near-term suggests a meaningful move higher near term is unlikely given the that the name is in a ‘show me’ mode. Instead, we think NKE and FL are considerably more attractive both on a relative and absolute basis over the coming year. NKE remains our top pick.

 

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