"Meet the new boss, same as the old boss."
Finish Line (NASDAQ:FINL) posted an exceptionally disappointing quarter that has completely eroded my hope that new CEO Sam Sato could drive a turnaround. While footwear was once again solid, the company's decision to pull out of NCAA fleeces caused a significant disruption in the apparel business, which likely cascaded into the footwear business. Although I exited my position in November, I believe fundamental business blunders and a lack of communication have greatly tarnished management's credibility. I think Finish Line has some decent underlying assets, but I would need to see shares trade at $15 before taking a position.
A lesson in guidance mismanagement
After a terrible Q3 in 2016 caused by supply chain disruptions, expectations were high for Finish Line. In fact, consensus estimates were calling for 8% same-store sales growth after the previous year's 5.8% decline, a sensible two-year stacked comp of 2.2%. Instead, same-store sales grew an anemic 0.9% y/y, resulting in total sales growth of 3% y/y to $372 million.
Generally speaking, this sort of Grand Canyon-sized disconnect doesn't happen. However, management failed to disclose that it was planning on eliminating its NCAA fleece business. The NCAA fleece business was surprisingly a real revenue driver for Finish Line, and as a result of its discontinuation, soft goods comps declined a whopping 37% y/y. Soft goods fell to 9% of sales from 15% of sales in the previous year. With such a downward trajectory that was obviously apparent during the quarter, management should have been straightforward and preannounced comps. Furthermore, it would have been exceptionally easy to model that pulling out of a business would lead to a significant decline in sales. Management should have and could have incorporated this feedback into Q3 guidance and framed the story as part of the turnaround. Instead, I now question whether management assumed it could simply flip a switch and replace a material amount of apparel sales. Remember the 20% recapture rate from store closings? I have zero confidence in that assumption.
Footwear as expected; Nike (NYSE:NKE) strong
As expected, footwear was strong growing in the high-single digits. Nike sales were robust in the usual suspects, i.e. Jordan Retro, Air Max, Huarache, and Presto. However, it was interesting to hear that the LeBron Soldier X, Jordan XXXI, and Kyrie 2 were all strong performers, given the recent underperformance of Nike basketball. This is a positive read-through for Foot Locker (NYSE:FL), which possesses an even stronger basketball offering.
Once again, adidas (OTCQX:ADDYY) was another strong performer led by Boost, Bounce, and adidas Originals. I was encouraged to hear that Reebok is making a comeback, and I think that brand in particular has some momentum going into 2017. This is very positive for adidas, and I think the company has a great chance to outperform peers once again in 2017.
Under Armour's (NYSE:UA) commentary was surprisingly positive as well. The Curry franchise continues to post strong y/y growth, and I may actually be too negative regarding Under Armour's current footwear trajectory.
Overall, the footwear trend looks strong, though it certainly remains competitive. The Jordan Retro 2017 slate is already shaping up to look fantastic, and I think Nike will do a much better job of hitting on key trends, with products like the LunarCharge foreshadowing new product launches in calendar 2017.
Footwear is still strong, but Finish Line is cutting price to stop the bleeding
Though it is crucial not to read too much into specific sales, I noticed that Finish Line has been ultra promotional in the fourth quarter. The company has often offered 20% off orders with minimal restriction - drastically different from a policy that generally excludes Nike, adidas NMD, and other good products. Management even noted that:
"The selling environment has been more promotional than last year and we expect this trend to continue through the remainder of the fourth quarter."
The promotional environment, which was mentioned 14 times on the conference call, led to terrible guidance. Finish Line expects comps to fall 3-5% after last year's increase of 4.6%. Even worse, gross margins are expected to fall 230-300 basis points due to discounts and occupancy deleveraging. In total, this brings full-year non-GAAP EPS to $1.24-1.30, down significantly from the first guidance we received of $1.50-1.56.
In total, Finish Line continues to drop the ball and does not appear to have any decent handle on the impact of certain business decisions on its total profitability. I now question not only the closed store recapture rate, but also whether management's decision to remodel stores will have a positive ROIC and whether the firm will be able to capture lost apparel sales.
Finish Line is a company that is lost. In retrospect, I traded the company well as a function of macro drivers that even a poor management team could not fumble. That said, the current management team is doing a nice job of hitting on popular styles, but I think tremendous operational problems remain, and I believe it could take an external sobering view to propel a true turnaround. I am reducing my Finish Line value range to $19-22. I will be interested in revisiting in the mid-teens, but for now, I will remain on the sidelines.
Disclosure: I am/we are long UA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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