Footlocker Rides Nike To Strong Second Quarter Results

| About: Foot Locker, (FL)
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Athletic and fashion retailer Footlocker (NYSE:FL) continues to post fantastic results, with the trend continuing during the second quarter. Revenue accelerated 7% year-over-year to $1.4 billion, which was better than consensus expectations. Earnings per share grew 63% year-over-year to $0.39, well ahead of the Street's expectations. Gross margins increased 90 basis points year-over-year to 31.3%, but initial mark-up margins are falling slightly. The company's partners have been dealing with higher costs and have shown an increased desire to capture more profit through the supply chain. Though the firm has clearly navigated an impressive turnaround, Foot Locker's shares look fairly valued at current levels. The company registers a 7 on our stock-selection rating system.

Most of the accolades for the quarterly results, released August 17, will go to Footlocker's impressive 9.8% same-store sales growth. The performance comes off a strong quarter in 2011 and amounts to a stacked two-year comp increase over 20% (we typically add the same-store sales performance in year-over-year quarters-a stacked trend-to better assess overall organic revenue momentum).

There are a number of drivers behind the strong same-store sales expansion. Over the past several years, Footlocker has focused on shuddering unproductive stores (mainly Champs' Sports), generating more productive storefronts, and consolidating overall foot traffic. Though this has formed the backbone of the company's turnaround, two other trends are really driving growth, in our view: higher average selling prices and strong product trends.

The footwear market in the US is incredibly competitive, but Nike (NYSE:NKE) is experiencing one of the strongest runs since Converse in the 1960's. Plus, Nike isn't just basketball and casual, but the brand extends into nearly every avenue imaginable. Footlocker CEO Ken Hicks pointed to strong performance from classic styles like Converse All-Stars (Nike), Blazers (Nike) and adidas Sambas. But with running flat year-over-year, the classic styles with lower price points haven't been the true drivers of higher average selling prices at the firm. Rather, Nike's premium and often limited products are what's driving the positive trends at the retailer.

Retro Jordan brand shoes (the shoes Michael Jordan played in during his career) are about as popular now as they were when originally released. Until mayhem over the Jordan XI Concord in December 2011, lines formed for days, even weeks, for the latest Jordan shoes. Demand is incredibly high, somewhat driven by Nike's limited supply, creating a huge market for end use, collecting and ultimately financial speculation (as odd as that sounds). Nike has consistently raised prices over the past several years, collecting outsize profit, but leaving some pricing upside to keep financial speculators engaged. Recent LeBron shoes released in late 2010, for example, retailed for $175 and now sell for upwards of $1,000. Footlocker doesn't even have to spend much money on marketing-buyers are simply flocking for desired product.

The same phenomenon is evident among other lines, including the LeBron James line, where buyers literally lined up for the privilege of paying $250 for limited "Elite" colors. Buyers that miss out on certain colors tend to purchase other shoes at the store after waiting for a few hours at Footlocker (improving overall inventory turns). Footlocker receives a larger percentage of premium products than any other retailer, excluding NikeTown stores, making its business superior to Finish Line (NASDAQ:FINL), in our view.

Nike's tremendous brand momentum in North America should continue, and incremental additions like Nike Elite Socks (MSRP: $14) will help Footlocker grow as Nike's preferred retail partner. Plus, we think Nike's recent partnership with the NFL will be a huge driver and could help improve apparel sales at Footlocker in the back half of 2012. Plus, the iconic black and red Jordan XI will release around Christmas this year and will likely be the most anticipated shoe release of all time. In fact, our outlook for Jordan, LeBron, Derrick Rose and other NBA superstars with shoe endorsements looks strong for the remainder of 2012.

We don't want to downplay what Footlocker has done over the past several years, including improved store optimization, better inventory management, a revamped Eastbay website, the successful launch of House of Hoops and repositioning of its Lady Footlocker brand. But it's hard for us to see Footlocker's strong same-store sales growth continuing in the US without a strong contribution from Jordan and other popular Nike lines. We've seen huge fads come and go in footwear, even within Nike itself, ranging from Air Force One's to Dunks to the current Jordan brand and Nike basketball cohort. If popularity wanes for the current 'hip' products, we think Footlocker will be in some trouble. The recent Nike+ Lunar Hyperdunk retails for an unheard of $250, so we wouldn't be surprised to see some customer defections if Nike and Footlocker continue to push the upper limits with regards to pricing.

Ultimately, Footlocker's shares look strong on a technical basis, and the firm registers a 7 on our Valuentum Buying Index (our stock-selection methodology). However, we think the brand is a US derivative play on Nike's premium product offerings, and it remains to be seen if Nike's marketing and demand creation is enough to sustain tremendous momentum at Footlocker. We remain on the sidelines for now, though we continue to monitor new developments at the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.