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Takeaway: As good as 4Q was, most metrics look sequentially worse to us. This is a fat-tailed short call, and we think it’s starting to play out.

FL numbers looked fine, good actually. But our point on the stock all along is that there’s asymmetric risk to the downside in a) the rate of change in fundamentals, and even more so b) the stock. FL beat by $0.04 ($1.16 vs the Street at $1.12) and put up a very respectable 7.9% comp. But…

  1. FL has beat every single quarter this economic cycle save one, and by an average amount well above what we saw today. This company is EXPECTED to beat.
  2. The flow through in profitability is less than half of where it trended 3 and 4 quarters ago. Compares are starting to get tough.
  3. Comp trends are disappointing in Feb, at a low-single digit rate month-to-date EVEN THOUGH a) there was a sequential uptick in Nike/Jordan launches this month versus last, and b) Feb 2015 was disappointing – so it faced an easy comp. i.e. there’s an increasing bifurcation between Nike’s solid release schedule and FL results. That’s bad.
  4. The steady sequential decline in e-commerce is unsettling, to say the least.
  5. Management sounded very confident in 1Q and the year – but this team only knows how to be confident. They’re reign started in the middle of the biggest multi-year surge in Volume and ASP-boosting Nike product since the early 1980s. Now that ends.

On Wednesday we said a whole mouthful on FL when we presented out 65-page Black Book – here’s the link to our report (CLICK HERE). This quarter was in line with our thinking.

 

Additional Details:

 

Comp Trends: Solid 4Q number at 7.9% showing an acceleration on a 2 and 3 year basis.  That was mostly generated outside the US, as the FL banner domestically put up a MSD comp for the first time since 3Q13. Quarter to date trends at LSD for the month of February are not encouraging.

FL  |  Eroding on the Margin - 2 26 2016 FL chart1

Monthly Comps: Below are our estimates of the monthly comps based on management commentary. i.e. MSD = 5%, LDD=11%, etc. We’ve now seen two consecutive months of LSD comp growth. Commentary around the February trend doesn’t add up. Per Nike’s website the basketball launches accelerated sequentially into the All-Star game and it is the easiest comp of the year for the company. From here, everything gets more difficult for FL.

FL  |  Eroding on the Margin - 2 26 2016 FL chart2

e-Commerce Erosion: Another bad indicator on the margin for FL who now competes directly with Nike online for dollars. Yes, FL has the stores that Nike does not, and there is still a place in this space for that experience. But, with more of the growth headed online we think a disproportionate amount of those dollars go directly to the brands – Nike in particular.  Nike hosted its analyst day back in October of 2015, where it laid out its $7bil e-commerce plan by 2020. A number that we think is low by $4bn. No surprise that the sales trends have followed the traffic trends at FL we’ve called out over the past few months at the same time Nike took its intentions public. Banner dot.com growth was just 20%, a big deceleration from the 50% we saw early in the year.

FL  |  Eroding on the Margin - 2 26 2016 FL chart4

Profitability: Incremental margin is down to 36% from the mid-70s in 1H15.  Now working against tough compares as comps moderate and spending accelerates. The leverage in this model is all but tapped, as noted by management on the call when talking about the need for MSD comps to leverage fixed expenses vs. the prior LSD.

FL  |  Eroding on the Margin - 2 26 2016 FL chart3