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Wednesday, December 2, 1998

An Investment Opinion
by Louis Corrigan

Shopping for Shoe Retailers

It's hardly news that the market for athletic shoes has lost its footing over the last two years. The Nike (NYSE: NKE) juggernaut that once drove the industry to a slammin' in-your-face jam depended on consumers' ceaseless appetite for ever-more-expensive Air Jordans and other high-tech, high-fashion sneaks. Despite the heroics of His Royal Airness last spring, not even Michael could do much to pump up the marketplace. More recently, even the '70s revival that gave new life to companies like Adidas has faded. Everyone's been talking about the move to so-called "brown shoes," with Timberland (NYSE: TBL), Doc Marten, and Skechers being some of the supposed beneficiaries. The NBA strike just adds another hurdle to any hoped-for sports shoe revival.

While the slowdown has been notable, it hasn't been as dramatic as one might expect. The Athletic Footwear Association reported that U.S. sales of athletic shoes leaped from $12.1 billion in 1993 to $14.1 billion in 1996, rising about 5.23% per year. Last year, sales popped up to $14.7 billion, still a 4.25% increase. The story of fickle fashion trends, then, appears to be only part of the story. The inventory glut that has produced widespread discounting throughout the industry seems partly a result of the overbuilding of specialty athletic shoe stores and the ongoing waves of consolidation/expansion that have been taking place as a result.

Venator Group (NYSE: Z), the company formerly known as Woolworth, has added Koenig's, Athletic Fitters, and Champs to its roster of players, which include the giant Foot Locker chain and its Lady Foot Locker and Kids Foot Locker sidekicks. This summer, it attempted to add The Sports Authority (NYSE: TSA) to its already market-leading 3,650-store base. However, each company's stock imploded as sales and earnings deteriorated. Some believe that aborted deal helped trigger Just for Feet's (Nasdaq: FEET) move to acquire the 38-store Sneaker Stadium chain. Last year, the fast-growing Just for Feet also bought Athletic Attic and Imperial Sports. It now has 315 stores, including franchised units.

The accelerated pace of consolidation triggered by the current troubles seems likely to produce a marketplace somewhat similar to other ultimately lower margin but comfortably profitable retail niches where scale matters. Think book and music retailing, or even video rental. Numerous independent or small-chain retailers still find a way to profit in these markets. In general, though, independents increasingly are being pushed out of business. Meanwhile, huge discount-oriented chains, like Wal-Mart (NYSE: WMT) and Best Buy (NYSE: BBY), have absorbed larger chunks of the market while a couple of specialty retailers in each niche have gained substantial market share. So we have Barnes & Noble (NYSE: BKS) and Border's Group (NYSE: BGP) in the book biz, and Musicland (NYSE: MLG) and Trans World Entertainment (Nasdaq: TWMC) in music retail.

Clearly, none of these markets are completely dominated by just one or two players, and the dynamics of each business are different. But any of these specialty retailers might have proved a nice investment play on its industry's consolidation, assuming you didn't ignore valuation. Moreover, it seems to me that books, CDs, and other multimedia items can be readily purchased over the Internet because there's little chance of buying the wrong item and being stuck with reshipping costs. The new Tom Wolfe is the new Tom Wolfe is the new Tom Wolfe. Apparel and shoes, on the other hand, are a slightly "iffier" e-tail proposition since even if customers know their size, they can't be guaranteed a comfortable fit. In other words, consolidation within the athletic shoe market seems less exposed to the (Nasdaq: AMZN) et al. Internet trump card that threatens to make price an even more important competitive issue.

Checking the current valuations, we see that a company like Just for Feet, which has maintained strong revenue and earnings growth throughout this rough period while remaining in good financial shape, has been rewarded. Others have fallen to near 52-week lows as we enter serious tax-loss selling season.

Company        Price     MC     EV  Sales    EPS  EV/Sales  P/E  EPS Next Yr
Just For Feet 20 3/4 731 747 696 0.94 1.07 24.5 1.40
Venator 7 1/2 1017 1378 6649 0.59 0.21 12.7 0.91
Finish Line 8 1/4 219 165 494 1.02 0.33 8.1 1.16
Footstar 23 589 626 1864 2.29 0.34 10.0 2.93
Sports Authority 6 3/4 215 361 1561 (1.79) 0.23 N/A 0.62

(MC is Market Capitalization. EV is Enterprise Value. All figures based on continuing operations, except for Sports Authority. The consensus EPS estimates for next year include some wide ranges, suggesting either staleness or divergent views on Wall Street. )

Operating results differ considerably between these players, as can be seen from a quick look at just three of them. In the quarter that ended October 31, sales at Just for Feet rose 73% to $226 million thanks to the Sneaker Stadium deal (which isn't fully factored into the above trailing sales). Net income jumped 87% to $10 million while EPS shot up 38% to $0.32 versus $0.18 a year ago. The company delivered a 3.1% gain in same-store sales on top of a three-year string of comp-store gains for its third quarter. Despite clearance sales related to remodeling its Sneaker Stadium stores into Just for Feet units, gross margins dipped only slightly to 40.3% from 40.9% a year ago.

For the same period, Venator reported a loss from continuing operations of $40 million, or $0.29 per share, versus a gain of $50 million, or $0.37 per share, last year. Sales increased by just $15 million to $1,122 million last year even though the company opened 384 new stores and saw some improvement in athletic footwear sales in the running, trail, and basketball categories. However, comp-store sales fell 5.3% as the company aggressively cut prices to clear out inventory. That move is reflected in the gross margins, which plunged to 25.1% from 33.1% last year. Yet the company still ended the quarter with inventories per store standing 17% above year-ago levels.

Meanwhile, during The Finish Line's second quarter, ended August 29, the company suffered from some of the back-to-school discounting seen throughout the market. Sales rose 22% to $145 million, but comp-store sales were flat despite a 4% uptick in comp footwear sales. Slackened demand for sports-related apparel led to discounting. That meant net income dropped 12% to $7.9 million and EPS fell by an equal amount to $0.30 as gross margins sank to 30.8% from 32.5% a year ago. Still, The Finish Line is noted for its tight merchandise management. Inventories per square foot declined by 9% even as square footage increased 36% as the company's store count went from 281 last year to 330. At the end of August, The Finish Line was sitting on about $2 a share in cash and marketable securities net of long-term obligations.

There could be both growth and turnaround bargains to be found among the top players in the industry, though others may lose out. To get some idea of the further changes afoot, consider that Just for Feet Chair/CEO Harold Ruttenberg sees that chain's base of superstores growing to about 400 down the road from 145 today. Meanwhile, the company plans to increase its presence as a mall-based specialty retailer by rolling out more refashioned Athletic Attic stores. The goal is $2.5 billion in annual sales, or about triple this year's pro forma revenues, in the next few years. Just for Feet is certainly not alone in looking to bulk up. As the leading players gain even greater market share, all should benefit.

Related Articles:
-- Daily Trouble, 11/06/98: Venator Group
-- Daily Trouble, 08/25/97: Just for Feet

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