This was hardly the typical blow out quarter for Nike. It had some noise. Sales decelerated on a 2-year basis in the US, with Europe and China both slowing on the margin. Beat of $0.04 (far less than we’re accustomed to from Nike) came entirely from SG&A. The absolute algo was more than respectable – with sales of +10% leveraging into EBIT and EPS growth of 18%. Inventories flat. Can’t shake a stick at that. If I was a long-only PM listening to this call, I’d have walked away saying something like “this team has a solid plan and they’re managing toward it. Let me check the box on owning this and move to other names in my portfolio that are not behaving so well.” After I did that, I’d kick myself for being a long only PM and not having the ability/mandate to short more FL on this event.
Seriously…I have not heard a more bearish conference call for Foot Locker since 2002 when both companies where at each other's throats. All Nike talked about were new digital capabilities designed to reignite Direct-to-Consumer growth for Nike – which already grew at an impressive 36% this quarter (12% including company retail). Digital demand sensing, consumer data and analytics, connected inventory, digital product design and creation, a digital content engine, and a new enterprise resource platform. This is end to end and the initiatives were so numerous I could almost not keep track. SNKRS app launching globally, sounding bullish about the new jet.com (WMT) curation initiative, and how (my interpretation) Amazon is going to have to play catch up with jet.com on such a holistic approach to sourcing product across multiple price points (that I think will overlap with those sold at FL). There was almost no mention of initiatives that will drive consumers to a mall to buy kicks at a Foot Locker, and certainly nothing that will lead FL to accelerate its own ecomm business. FL is gonna trade down tomorrow. It has to. But I still think that over a TAIL duration FL will look twice as expensive at half the price. It has $2.00 in EPS risk, off a $4.50 base, and that’s a severe problem.
So what about our positioning on Nike? I’ve had this as a Best Idea short side since $75 after being an uber-bull. I am 100% certain that there is far more turmoil inside the Nike org chart right now than the market knows (or cares) about. My contention is given that the dozens of firings (yes, more than the press releases told you) were disproportionately on the brand and product side of the organization, it will ultimately come back and cause growth to slow in 2H of this fiscal year. Are we starting to see this? Yes, but it is VERY slight. My sense here is that the quality and depth of this organization is mitigating what could otherwise have been a disaster for the top line at this company. In effect, this company is earning every last bit of its multiple as it manages through the most difficult internal culture shift in its history.
I’m so tempted to remove this name from our Best Idea short list because of the resilience we’re seeing in the model so far. But the reality is that we started to see slight underlying slowdown in top line this quarter, and Hedgeye’s Macro view on China, Europe and Emerging Markets remains clearly to the downside at a time when US Retail Brick & Mortar traffic is looking toppy. This is the first time in my career where my annual estimates are not above consensus, and with the stock set to open at 29x earnings, I think upside is meaningfully limited. Is this a great short like HBI, KSS or M? No. The TAIL call here is money. But it’s dead money at best with the stock supporting an 8-handle. At a minimum it buys me another 1-2 quarters to see if this TREND call plays out. Will I try to talk you out of owning this name if you have a long duration? No way. But I think buying more today at this price is reckless.
In the end, if there is call to action from this event, it is to borrow whatever FL you can and short it.
