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Takeaway: Moving FL up to our Core Short list. Key issue “what he no longer sees that is making him go”. Similarities to Murphy/GPS are startling.

Conclusion: We’re moving FL up from our Short Bench to our Core Shorts.  The announcement of Ken Hicks retiring as CEO is the icing on a cake that was already baking. To be clear, we don’t think that FL is in trouble because Ken Hicks is leaving. We think that Ken Hicks is leaving because Foot Locker is in trouble. The juxtaposition here with Glenn Murphy leaving GPS last month is striking. Both of them; a) are seasoned executives, b) joined their respective companies within a year of the last recession (and trough margins), c) have hit home runs with zero square footage growth retailers, and d) are leaving for no apparent reason. How can this be anything other than a negative signal for where we are in the retail margin cycle? We’ve been harping over and over again about how we are in year six of a six year cycle. We can’t help but think that these two gentlemen are validating that premise.

Another point…one thing that kept us on the sidelines about pushing the FL short case was all the talk of an LBO. Even though we thought it was ridiculous, the reality is that the math works for someone gullible enough to straightline current margins into perpetuity. But would Hicks be walking out the door if the company was being shopped to buyers? Probably not.

As background, we added Foot Locker to our Idea Bench in August as a short. Trends look fine today, as better product from Nike and UA on top of more efficient store formats are pushing productivity past old limits. But sometimes limits push back. Today FL is operating in excess of $500/ft, which is about 25% higher than historical peak, margins are setting new peak levels at 11% this year, and the stock is trading at 15x forward earnings (close to peak).

Since August, three things have happened, all of them negative.

1)       Europe has started to soften for many retailers on the margin, including footwear and apparel.

2)      Nike and UnderArmour both put up stellar consumer-direct comps, with e-commerce readings literally off the charts. We’ve never seen the athletic brands so blatantly aggressive in growing outside of the traditional wholesale channel.

3)      Ken Hicks stepped down. This is the icing on the cake. The guy was money for FL, and for shareholders. The stock has been a 4-bagger since he was appointed in Aug 2009. He has beat two sets of long-range objectives in half the time intended. We know that he has groomed Johnson and other top talent to take his role in as seamless a manner as possible. But it’s just not enough.

We’ll be back with more detailed analysis on our short thesis.

FL - The Last Straw - 11 4 2014 6 02 45 AM