Please…somebody explain to us how the charts below are not really bad for FL. Specifically, the online data we track – from a number of sources such as Alexa, Compete, Google, and Comscore as well as our own analysis – shows a continued slowdown in Foot Locker’s online business since the end of the third quarter. This is not just an industry thing, or a category thing. We’re seeing Nike’s web traffic explode to the upside (‘explode’ is a strong word, but when you see the chart you’ll get what we mean), UA and AdiBok tracking well, suggesting that the share shift from traditional retailers to the Brands is taking hold. While the data looks quite ugly for FL, we want to reiterate that this is a fat-tailed transition that won’t play out entirely in a single quarter. But, the negative on-line trends for FL that reared its head in 3Q seems to be carrying into 4Q.
As a reminder, FL is at the top of our Best Ideas Short List. While our short thesis goes far beyond a few unfavorable data points, the question around timing has been a big issue for people who agree with our TAIL call, but can’t quite get there over the near term. For many reasons, we think that $4.20 will likely prove to be the high water mark in this economic cycle, and the consensus estimates in years one through three are high by $1-$2 per share. We think that emerging competition from its top vendor, Nike (≈80% of sales), will stifle growth, and leave the company with an earnings annuity somewhere around $3.50-$3.75 per share. Is that worth $64? Not a chance. Not for a company that is Nike’s best off-balance sheet asset. And definitely not when the Street is in the stratosphere approaching $6.00 in EPS (#NoWay).
Importantly, we think people generally misunderstand why the rate of growth between Nike and Foot Locker will be slowing materially. It’s not because Nike hates its largest customer. It’s not because the ‘basketball cycle’ is rolling over (the basketball cycle actually does not exist, at least in the way people think). It is slowing because Nike has largely tapped out its growth inside higher-end US distribution, and simply has to turn to its own DTC platform – which finally exists after nearly a decade of investment. Yes, it used the cash flow from US wholesale growth to fund growth around US wholesale when the time arises. It’s as simple as that. And yes, the time has arisen.
TRAFFIC RANK (EX 1): This is primarily made of Alexa data, which shows the year-year change in the web rank for footlocker.com. “Web Rank” is simply a relative measure of footlocker.com’s total traffic by week relative to the average company on the web. Looked at in isolation, the data for a given quarter is rather useless, but on a year/year basis, it becomes quite relevant. Note that FL’s e-commerce growth fell to +29% in 3Q versus +40% in 2Q – marking the first time in two years we saw growth below 30% in this business. The trend in the chart below accurately captured that slowdown.
SEASONALITY: It’s important to look at the seasonality of traffic. After all, each retailer has its own cadence on a week to week basis. Our point is that you can’t compare FL vs DKS, as the seasonality of the sporting goods business is different from mall-based athletic retailers. Exhibit 2 shows that we should have seen a notable seasonal upswing in October of 2015, but we really didn’t see much of anything. Just a flatline. The gap between this year and last year is exceptionally tight right now. Too tight.
BRANDS vs RETAILERS: Exhibit 3 shows the performance (web traffic) of FL vs. a composite of the brands. While all major brands are on a healthy trajectory, Nike makes up for the biggest upswing. Needless to say, look for Nike to put up a big e-commerce number when it reports next week. Nike will still talk about how they still love their wholesale model, which they do. But that does not mean that they won’t grow around it to put up results shareholders demand.
Looked at a different way, Exhibit 4 shows that the traffic spread is growing at an accelerating rate and is sitting at historical peak.