A touch of optimism can produce dramatic price swings in an out-of-favor stock. Foot Locker (NYSE: FL) shareholders experienced that happy dynamic last week when shares soared by over 20% following the footwear retailer's earnings report.
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Nike (NYSE: NKE), its main supplier, also had a strong week as investors bet that good news for one company would likely translate into good news for the other.
Let's take a closer look at the report.
The good and the bad
Foot Locker's top and bottom lines are still headed in the wrong direction, but the figures weren't nearly as bad as Wall Street had expected. Comparable-store sales slipped by 2.3% to mark a solid improvement over the prior quarter's 6% slump. The comps figure also edged past management's forecast that in August predicted declines of between 3% and 4%.
In addition, Foot Locker made painful but necessary progress in aligning its business with the new sluggish selling environment. Management cut corporate staffing levels while closing 24 locations in the U.S. market. It reduced prices on slower-moving merchandise, and the result was an improved inventory position heading into the key holiday shopping season. Inventory levels dropped 3%, and executives said the remaining holdings were tilted toward fresh, innovative merchandise. "The availability of premium product is gradually improving," CEO Richard Johnson said in a press release, "and we believe we can achieve, and perhaps modestly exceed" holiday season guidance.
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Foot Locker's business is still dealing with major challenges, though. The price cuts hurt profitability, for example, with gross margin falling to 31% of sales from 34% a year ago. Johnson and his team said they're still seeing a "highly promotional environment" in the industry as rivals compete over a shrinking pool of customer traffic. That competition helped the retailer's third-quarter earnings haul dive to $102 million from $157 million.
The Nike impact
Still, the overall results suggest that the sneaker retailing world could be stabilizing thanks to the combination of reduced inventory and a quicker pace of product introductions. That's essentially the dynamic Nike predicted for the market during its October investor presentation, when the sports-apparel and footwear titan told shareholders that it believes profitability will expand in the U.S. segment even as sales growth stays modestly positive.
Those optimistic predictions clashed with Under Armour's (NYSE: UA) (NYSE: UAA) official forecast that came just a few days after Nike's investor presentation. In its third-quarter report, Under Armour lowered its 2017 outlook after the company posted its first year-over-year quarterly sales decline as a public company.
Nike has a few advantages over its smaller rival that should help it enjoy better operating results through the holiday season. Its business is more heavily tilted toward fast-growing international markets, for one. Nike also gets far more of its sales and profits from footwear, while Under Armour is still predominantly an apparel company.
Thanks to Foot Locker's recent comments, investors have another data point that supports Nike's brighter reading of the core sneaker business. Sure, the retailer's declining comps and slipping profitability both suggest struggles during the holiday season. However, the fact that sales trends are improving means new product introductions like the ones tied to Nike's VaporMax and Air Max running platforms are finding early traction in the market.
Those innovations, plus the reduced inventory and store footprint that the retailer announced, will make it easier for Foot Locker to meet or exceed management's full-year operating outlook. The news also means Nike is closer to stabilizing its U.S. business -- a key plank in management's goal of steadily improving overall sales, profitability, and return on invested capital between now and 2022.
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Demitrios Kalogeropoulos owns shares of Nike, Under Armour (A and C shares). The Motley Fool owns shares of and recommends Nike and Under Armour (A and C shares). The Motley Fool has a disclosure policy.