Over the past year, the US footwear market has been on fire. Dick's Sporting Goods (DKS) and Footlocker (FL) have seen their shares surge significantly, while Finish Line (FINL) has underperformed the cohort and the S&P 500. We think this trend might reverse in the fourth quarter of calendar year 2012, and we think shares of Finish Line have more upside valuation than either retailer at current levels.
Moving Towards Nike Premium Products
Without question, Nike (NKE) has been a major driver for both Footlocker's and Dick's Sporting Goods' recent strong performance. For an in-depth read on how we calculate the intrinsic value of Nike and its peers, please click here. We've even labeled Footlocker as more of a pure play on Nike's North American business (which is doing great), while Dick's has reaped benefits from both Nike and Under Armour (UA). Since Nike and Footlocker rekindled its relationship after a brief falling-out in the mid-2000's, Footlocker has been the primary receiver of premium Nike products, which, in our view, have driven traffic, sales growth, and improved gross margins at the company. Footlocker's House of Hoops receives several exclusive shoes and allows the retailer to spend less on marketing since Nike takes responsibility for that.
However, we've seen a swift, under-the-radar change in product mix. For instance, based on the first release last week, we have reason to believe Finish Line will be receiving the premium LeBron James line. Since a major overhaul in 2009, the LeBron line has exploded on the scene and has become the most popular signature shoe since Michael Jordan's. Nike releases several limited quantities of sought-after colorways that drive collectors wild and set-off frenzies in the secondary market (prices explode much like a sought after IPO). Finish Line will likely receive these popular products, which will slightly boost sales and margins, but more importantly, bring collectors back into stores and on the firm's website. These collectors don't simply buy a few pairs of running shoes a year, but they are often interested in purchasing upwards of 20 pairs, as well as high-margin socks and accessories. Finish Line has traditionally catered more toward middle-America, so getting this customer back in the stores is a huge boost, in our view.
The winter holiday release schedule for Jordan Brand (Nike) is also incredibly strong. The popular "Black/cement" Jordan IV will be released on Black Friday, and the Jordan XI (which caused a stir last year) will be released a few days before Christmas. We think the Jordan XI release will likely be the largest single shoe release of all time-a pretty big deal for retailers.
Further, Finish Line has also been the preferred distribution channel of Nike's new Flyknit technology. We've been monitoring sales, and the shoe doesn't seem to remain in stock for very long (based on the small sample set of stores we visited). Oddly, we haven't seen Flyknit shoes hit Footlocker or Eastbay, and the only other places we've seen the product are at Nike stores and at local running shops. The firm will also benefit from carrying adidas' Rose 3.0, which we suspect will be among the hottest selling shoes during the holiday season.
NFL License Upside
Since exploding in popularity in the early 2000's, jerseys and athletic apparel have consistently shrunk in popularity, but that trend looks to be reversing. According to SportsOneSource, NFL apparel sales are 2.5 times the size of Reebok sales last year thanks to popular new styles from New Era Headwear, as well as Nike. Since Finish Line stores tend to have more room for apparel than Footlocker stores, we think the company will see a nice benefit as sales rise during the holiday season and fans accumulate new jerseys and apparel.
When management guided to low-single-digit same-store sales growth during the second half of its fiscal year, the NFL rollout wasn't quite complete, and we think the company may not have fully appreciated the upside potential that this deal could ignite. Let's not forget Peyton Manning, Tim Tebow, and Brandon Marshall changed teams this offseason, while exciting rookies like Robert Griffin III and Andrew Luck have entered the NFL--meaning there are several players that fans will consider their jerseys to be must-haves during this holiday season. The Tim-Tebow effect also remains a small, but possibly meaningful, boost. Assuming the New York Jets quarterback eventually claims the starting position, we think Nike will roll out several exclusive Tebow products, and we expect all of his merchandise to fly off shelves. In the long run, the impact will be immaterial, but it could serve as a nice near-term boost.
Additionally, SportsOneSource noted that running, specifically Nike Running, had returned to mid-teens growth in September after sales had lagged during much of the year. Both of these developments will help boost Dick's Sporting Goods, but we think the marginal impact will be greater at Finish Line. Its stores prominently display running products, and we suspect the sport will remain incredibly popular as long as the economy remains weak. For many, running shoes at $100 are a relatively cheap health and hobby investment.
In a possibly brilliant move, Macy's (M) signed a deal with Finish Line to allow 450 FNL "store within a store" concepts nationwide. Needless to say the additional retail outlets for Finish Line will be a nice gain for the store, but we think Macy's is the real winner of this deal. Unlike Nordstrom (JWN), Macy's has been unable to receive premium athletic footwear products. This should change with Finish Line in the mix, boosting the prestige of Macy's footwear department.
The risk, in this situation, is that Nike gets upset with its premium product appearing in a non-premium store-as a result, it could "punish" Finish Line by negotiating stricter deals or by not selling them product. Nike isn't afraid to alienate its retail partners, but we think the company will be more hesitant since its feud with Footlocker hurt both companies a number of years ago.
Ultimately, we think Finish Line's second half guidance was fairly conservative, and we believe its earnings guidance leaves considerable room for an upside surprise. We were also surprised that the company wasn't better rewarded for its 12.3% same-store sales growth during its second quarter (on top of 11% growth in fiscal year 2011). At just 13 times forward earnings, compared to an industry median of 16 times, Finish Line has relative value. Still, the company trades within the lower bound of our fair value range, so we're waiting patiently. If shares fall below the low end of our fair value range, however, we'd consider adding them to the portfolio of our Best Ideas Newsletter.