FL | Many ‘Un’happy Returns

Takeaway: FL spending is headed up on PP&E and SG&A in the face of significantly more challenging growth. How could this be good?

Foot Locker’s big capital spending plan announced last night is anything but good for the financial return profile, and the stock. The company’s capex number for the upcoming year is expected to clock in at $297mm. That’s the most FL has spent since 1999, and it represents a 26% increase from the already-elevated levels we saw in 2015.


As context, our extremely negative long-term view on FL is predicated upon an unsustainable financial model, and a mismatch between how much FL is spending on both the P&L (SG&A) and on PP&E to drive the business forward in a changing footwear retail selling model.

Specifically, Nike has been spending on building up a world-class e-commerce model for the better part of 8-years – basically this whole economic cycle – and we’re now seeing Nike’s growth go parabolic, while FL’s is rolling over. Over that same period, FL’s ‘Nike Ratio’ (percent of inventory purchases that are Nike) has gone from 50% to almost 80%. It literally can’t get much higher. The same directional trend holds true for almost every other retailer that sells Nike. We get so much pushback on this – but our strong view is that Nike was stuffing the wholesale channel in the US in order to fund over $1bn investment in its DTC model. ‘Stuff’ is a strong word in retail, but call it what you want. As that ratio goes up, so does traffic (otherwise in a secular decline), ASP, revenue, margins and ROIC. EVERY single one of those things has happened at FL.


Now the paradigm is changing. Nike’s spending growth is rolling off as it harvests its investment by way of adding another $10bn in e-comm sales in 4-years (off a $31bn base). It’s e-comm numbers are completely blowing out to the upside. It wears its ‘we love our wholesale partners’ face proudly in public, but in reality it does not need to GROW that channel, it just needs to sustain. That’s a disaster for anyone who hangs their hat on selling branded athletic footwear for a living.


For FL, we’re looking at a company with a near 80% Nike ratio, productivity and margins that doubled in 8-years, leading to EPS up 4x, and RNOA up from 5% to 30%.  Now we’re seeing capex push shift from OEM to the retailers, but that investment for companies like FL is still likely to result in declining earnings. One of the factors that so few talk about is the SG&A base at FL – which is only 19% of sales. That’s astoundingly low, but was easy to sustain while Nike was stepping up its commitment to the retail channel. Now, FL will need to spend more to stay still at a minimum.


This stock will be choppy quarter to quarter. But last we checked, stocks don’t go up when financial returns get cut in half.


And if you question exactly why the capital spending pressure is being felt by FL, check out this chart. It shows the athletic brands' e-comm visitation rate less FL. Nike is winning online in bursts of share gain. 


FL | Many ‘Un’happy Returns - FL NKE visitation 2 18


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