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Finish Line provided another set of positive data points for the athletic footwear space with the reporting of its much better than expected results. The good news here is, we believe the industry hasn’t really hit its stride yet from a product and marketing perspective.  The benign promotional environment, tight inventories, and category strength in running and toning are the primary reasons why we’re seeing an accelerating trend at retail across much of the space.  However, we have yet to see much from Nike in terms of its product and marketing push- all of which are key to our longer-term thesis that the company is setting up for a three year period of above-trend growth and earnings acceleration.  Along the way (i.e. back to school), we’re likely to see continued strength as product driven demand continues to build.  As a retailer, be it Finish Line or Foot Locker, there is no better way to capitalize on what we believe is a sea change in the space over the next couple of years.

Importantly, Finish Line’s conference call confirmed that at the moment, this is a sector where we can see more than one player post solid sales and margins without it being at the expense of a competitor.  In our view, the single biggest factor in this equation is inventory.  Coming out of 4Q, both Finish Line and Foot Locker reported substantial inventory declines against accelerating (and positive) top line momentum.  FINL reported inventories down 20% against an 8.1% sales increase while FL reported inventories down 7.4% against a 0.6% increase in sales.  As such, we are in scenario that we haven’t seen in quite some time across the athletic space.  Tight inventory, low levels of aged inventory, and consequently less promotional activity.  As we are seeing first hand, this the key driver of ASP increases and quite a healthy scenario for both mall-based chains. 

As it pertains to Foot Locker, it’s important to remember that this is also a company in the very early stages of a major turnaround.  The tailwinds impacting the entire space are gravy on top of what we believe is one of the more compelling opportunities on the long side.  As such, we must be mindful of the separation between a rising tide that is currently lifting all boats and the efforts underway by Foot Locker management to permanently enhance the company’s sales productivity and operating margins.   We still believe the biggest near-term milestone for Foot Locker will come with back-to-school.  This will be our first opportunity to really understand and observe some of the key merchandising, marketing, and store segmentation efforts underway.  Until then, expect the overall demand for athletic apparel and footwear to remain robust, providing substantial support to our thesis, but at the same time reminding us that FL’s heavy lifting is still ahead.  With that said, there were still some notable call-outs from Finish Line’s conference call which we believe are pertinent to Foot Locker and the overall space:

  • Post 4Q trends have dramatically accelerated, with quarter to date same store sales running up 15.5% against a 1.2% decrease in the same period last year.  For reference, Foot Locker mentioned it was tracking up 6% through the very early part of March.  This is the first data point we have gotten in the sector which suggests there is more to be positive about than just easy comparisons.
  • Performance running was a key driver in 4Q and continues to be the leading sub-category within the store.  This is consistent with commentary from FL and HIBB and is fully supportive of FL’s efforts to test and potentially roll-out its RUN concept store.
  • Basketball beginning to show some signs of life.  This is key for Foot Locker, which has a much bigger presence in the category vs. Finish Line.  Basketball has been lagging (likely due to higher price points and lack of product intros), but positive commentary is encouraging.  For Foot Locker, we believe this bodes well for the impending re-acceleration in House of Hoops growth.
  • Finish Line is looking to cull its store base with 30% of the chain up for lease renewals but is not really looking to grow (at least near term) units on a net basis.  Recognizing this is not a growth sector by any means, it’s good to see both major players no longer growing for the sake of growth.  Making efficient use of existing real estate appears to be at the top of both FL and FINL priority lists- a factor which should not be ignored as we consider the potential for margin expansion for both players in the mall. 

Full notes/details from FINL’s call:

Product and Category Review

  • Product Assortment:
    • Leadership position in running, happy with the performance of the running category, high comps and improved merchandise margins, picking the right product to have in doors
    • Toning category is extremely successful and will continue to take full advantage of this trend, believe the category will strengthen throughout 2010 and beyond as brands invest in the shoe
    • Carrying the Best Brands:
      • Footwear: Nike and Puma in running
      • Apparel: The North Face, Under Armour, Brand Jordan
  • Footwear Comps: +10%
    • Running leading way in men’s and woman’s, Toning made a big impact, ASP's for footwear up 7%, strong sell thru at full price for performance footwear. Customer is embracing performance footwear as fashion.  Overall running was the key driver of comps in Q4, Nike continued to be the leader within running. Lightweight models such as Lunar and Free, as well as Air Max and retro-inspired silhouettes performed well.
    • Puma Running came on stronger in Q4
    • Running Comps up double digits
    • Nike Puma and Asics will continue to deliver solid product in 2011
  • Basketball: encouraged by improvement, comps up in mid singles driven by Brand Jordan as well as Nike’s Lebron signature products.  Enthusiastic about basketball going forward. 
  • Toning: Women’s products dominated with Skechers and Reebok, sold through all the Reebok product quickly but are taking necessary steps to get product in stock. Expect to see toning continue to grow in fiscal 2011 as other vendors enter this category
  • Athletic Casual Category: continues to be challenging with comps down mid-teens
    • Men's performed better on a same-store basis compared to women's in Q4.
    • A bright spot was men's Polo launch, which took place late in the third quarter, expect to see continued positive results as they work with Polo to expand and enhance assortment.
  • Kids: comp store sales were up almost 7% for the fourth quarter and were up slightly for the year.
    • Stronger in girls than in boys.
    • Driven by running as Nike Air Max, Puma and exclusive products performed well.
    • Brand Jordan and Skechers Twinkle Toes were also big hits.
  • Softwoods’ comps +9%, apparel and accessories posted solid gains
    • Apparel: worked hard to right size inventory, heavy lifting is behind them.
    • TNF, Brand Jordan, and UA drove the apparel business
    • Licensed products were positive with particular strength in NCAA fleece
    • Expect apparel business to continue to perform well now that they have completed the rightsizing of the inventory and put a strong emphasis on leading brands. The larger gains we experienced upon taking these actions will now level off to a more sustainable growth trend.
    • Accessories: Watches, Sunglasses, Socks
  • Looking Forward:
    • Emerging Channels: Mobile Commerce, evolving with the consumer
    • Light weight running trend will continue to succeed driven by Nike and Puma
    • Basketball’s improvement is encouraging and expect it to continue
    • Month to Date: +15% comps
      • Subtle shift in the mood of the consumer
      • Although the customer is not visiting the malls as much as last year, they are willing to pay for the full price

Q&A:

  • Running: Running success is not an overnight trend of the business, have been working on the category for 12 years.  Have worked with NKE management to take the leadership in the running category.  The product engine continues to flow from Nike, Puma, and all the technical brands.
  • Expenses: Permanent reductions made in 2009, only new costs going forward will be variable.  Still areas of opportunity to go after cost reductions.  Shifting focus from cost savings in 2009 to driving top line in 2010.  Will grow SG&A to support Sales.  Will not need more labor.  Efficiency program more than labor additions in SG&A.
  • March Trends: Traffic trends behind the 15% comp is a little better, flat, clearly big drivers have been conversion.  Inventory is the lowest in the 21 years they have seen.  The mix ends up being the best product due to such tight inventories.
  • Toning: a sustainable business, not seeing cannibalization of other categories (women’s running was strong in Q4). Still too early to tell if there are repeat customers. 
  • Growth: plenty of room to grow profit and sales.  Internet is great. Looking to grow outside of the core of the business.  Have learned from prior experiences and  will use those to head in the correct direction instead of hesitate and be discouraged.  Shareholders should be aware that FINL is working on other avenues outside of the core business to drive growth. Not prepared to discuss these avenues of growth but working on them currently.
  • SG&A: leverage occurs around -3% to -4%, leverage position will come down a bit but still remains at a slightly negative comp.  Absolute dollars SG&A growth will be up if sales are up, down if sales are flat.
  • Long Term Size of Finish Line Store Base: size of the stores is more related to the size and the volume of the malls they operate in.  “A” malls will have larger stores, lower level malls with less traffic will have smaller stores.  Long Term store portfolio depends on the landlords.  Will stay in those 20-30 stores planned to close if the real estate community offers better opportunities.
  • Staying Liquid with Open to Buy: recipe for inventory cleanliness.  Have worked hard on reducing aging inventory as a % of the mix.  Inventory levels are up in running and toning and other successful categories.  
  • Regional Trends: Sales across the country are consistent right now.  Not making up the difference of what they lost in the West, but trends have certainly stabilized.
  • Management: Very Optimistic Group
  • Real Estate: 30% of the store base is up for renewal in the coming year, hope to not close the 20-30 stores.
  • Reaction to Foot Lockers Apparel Renovation: Will stay strong on strategic initiatives, competitors will help drive FINL into a better business.
  • Apparel: real growth came from the men’s apparel
  • Casual Footwear Business: relative to the inventory position, athletic casual segment is part of the strategic reduction. As they focus on the performance side, casual athletic shrinks.  Still focused on the fashion elements of casual athletic.  Much more focused category going forward.  Polo is resonating well with customers in a pure fashion play.  Nike, Adidas, Chuck Taylors (growth slowing down a bit) all offer solid casual athletic product. 
  • Sales, Inventory, Margins: Key focus has been growing sales faster than inventory.  Margin expansion might slow but will continue to improve, but the sales-inventory rate is the key focus.  Still not at the best historic level of inventory turns.  At just over 2.7 inventory turns and have more to improve. 
  • ASP’s: selling more product at regular price.  More runway for ASPs but too early to tell.

Eric Levine

Director