After FL’s shellacking on Friday on a disappointing comp, we’re covering our Short and – I never thought I’d say this – we’re going Long. Let’s just pause and recognize the magnitude of this move for a minute…I’ve hated this business model steadily for over 20-years (and the stock on and off during that period), but I’ve never been long the Locker. Not once. FL has occupied its real estate on our Best Ideas Short list for longer than any idea I have on my Position Monitor. My stance has been that the core business (mall-based athletic retail) is a long-term loser as its clout with key vendors diminishes, it incrementally gets less high-end product, which will pressure in-store comps and lead to a shrinking store base.
Much of that rings true, but several key factors in the financial model are inflecting, and I think it is presenting an opportunity for people that go deep on the numbers.
First off…the quarter wasn’t as bad as the price action suggested. The comp of -2.7% clearly disappointed. But when you look beneath the surface, the Street was not contemplating that 10% of the stores would be closed. Europe, Canada, and Asia were all down double digit (Int’l is 30% of sales) due to stores being flat-out shut down or operating under reduced hours. Gross Margin in the quarter looked solid – up 156bps vs last year – and inventory was down 24%, which is GM-bullish headed into 1Q. So was the quarter a victory? No way. But the negative trends we saw are likely non-sustainable.
Secondly…the product calendar looks stellar for 1Q. The port congestion pushed out an important Yeezy (Adidas) launch from 4Q into 1Q, and we think it’s already sold out at full price. There are two more Yeezy releases scheduled for 3/20 and 3/26. The NBA All-Star game, which usually results in product flow in the final two weeks of January leading up to the event (particularly from Nike), was pushed out to March. A Jordan 4 also released this weekend (looks like already sold out). Hotly anticipated Nike Dunks that were expected to go on sale in late January are being released on 3/9, with additional Dunk launches on 3/6 (big Jordan Retro 1 launch), 3/10 and 4/2. The point is that the product calendar looks extremely favorable for the upcoming quarter – the same time the company goes up against a -43% revenue comp from a Covid-impacted quarter last year.
The punchline is that we think that 1Q Revenue should come in north of 50% at an incremental 1,000bp Gross Margin relative to last year. We have EPS clocking in at $1.24 vs the Street at $1.03. Something to keep in mind is that we have EBIT dollars of $164mm – but if you look at the first quarter in the five years pre-Covid, the WORST number we ever saw was $229mm. Our above-consensus number is 28% below that level. Store closures will continue to hurt, but if anything we think there’s upside to our number.
For the year, we should see an unusual shift away from e-comm and into store-based transactions – we’re modeling e-comm to be about flat for the year with store sales +8.4%. That’s Gross Margin accretive. All in we’re looking at an algorithm of 6.1% revs growth, 17% growth in Gross Margin, and 69% growth in EBIT. Tack on share repurchases and we’re got 96% EPS growth – or $5.52 with the Street sitting at $4.60. I can’t recall a time in over 20-years of covering this stock where we’re 20% ahead of consensus for the year. I think 12x an above-consensus number is fair, which suggests a $66 stock – $18 (40%) higher than where it’s trading today. If I’m wrong, then we’ve got 9x the consensus, which is $42 – or $6 (14%) below where its currently trading.
In subsequent years, we’re modeling ~2% comps (+30% online and -10% in-store) with slightly pressured (9% down to 8.5%) EBIT margins. Nothing to write home about. But then we’re giving the company $500mm per year in repo, which eliminates 35% of the float over a TAIL duration and drives 10% EPS growth on flattish EBIT. That gets to $7-$8 in EPS over a TAIL duration.
So on the core business, we’re looking at $6 downside if I’m wrong on the model, and $18 upside (or better) if I’m right. And that ignores the elephant in the room. That Elephant is GOAT.
GOAT (www.GOAT.com) is an online marketplace for ‘marquee’ athletic footwear and apparel. It pushes the limits in price points for both footwear and apparel (not uncommon to find $1,000 kicks), and is viewed by Nike (and therefore by default, the rest of the industry) as THE place for authentic full-price sales of premium gear. Data is sparse, but our sense is that 2020 GMV was about $1.5bn with sales of ~$300mm and positive EBITDA. Growth exit rate was ~100%. Both GOAT and StockX (a similar concept) are likely to IPO within 12-months. These two concepts are doing to the industry today what Foot Locker and Finish Line did 30-years ago when the mall was still a destination. GOAT sells more than 350 brands on its platform, has 13 authentication and distribution centers in the US, Europe and Asia, and ships to 170 markets. In other words, it’s arguably more global than FL is. Importantly, it sells kicks at a pricing tier well above FL, which should keep cannibalism to a minimum as the premium platform scales. These deals are going to be hotter than hot, and are likely to have market values that dwarf the traditional mall-based footwear retailers given the higher-quality full price merchandise, the sheer growth, and we think will be valued like platform such as Poshmark. When GOAT IPOs, it’s not unrealistic to get to a $8bn-$10bn valuation based on 3-4x forward GMV estimates.
Foot Locker has made a lot of mistakes over time, but perhaps the smartest thing it ever did was invest $100mm for a minority interest in GOAT in February 2019. We think FL’s ownership is ~15% of GOAT, which suggests $8-$10 per share in value for GOAT using more conservative valuation assumptions.
So in the end, there’s $6 downside in the core business if it fails to deliver on a rebound in 2021, but $26+ upside including its share of GOAT. I don't think I have it in me to ever make this a Best Idea Long, given that long-term EBIT growth is so muted and the future of the industry lies in brand DTC and high-end models like GOAT and StockX. But the risk/reward setup hasn’t looked this good for FL in a long time.
-- McGough
