Foot Locker (FL 2.83%) recently announced mixed earnings results as the retailer closed out the first half of its fiscal 2020. Sales growth came roaring back in its second quarter, allowing management to reinstate the dividend after just a one-quarter hiatus, but that good news was tempered by falling profititability and a soft demand outlook.
In the earnings call, CEO Richard Johnson and his team revealed the biggest factors driving those trends while suggesting investors brace for some rocky results in the short term. Let's look at some highlights from that presentation.
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A good quarter for growth
[O]ur premium business was strong throughout the quarter, and despite being a more promotional marketplace, the increased consumer appetite for the key marquee franchisees really showcased the health of our categories.
-- Executive VP Andy Gray
Foot Locker benefited from several positive trends, including pent-up demand following COVID-19-related store closures, federal stimulus support, and popular new launches from its main supplier, Nike. The chain even saw a boost to its basketball footwear despite the pause in sporting events, thanks to the popularity of the hit documentary on Michael Jordan, The Last Dance.
These factors contributed to 19% higher sales in the quarter compared to a 40% decline during the early innings of the lockdown period. "We are pleased by the health of our category, our deep connections with our customers, and the strength of our vendor relationships," Johnson explained.
Staying nimble on inventory
Results were also aided by elevated promotional activity as we focused on clearing slower-moving goods, as well as backed-up inventory deliveries from Q1. We ended the quarter with improved inventory levels.
-- Johnson
Earnings were hurt by the pricing pressures Foot Locker hinted at earlier in the month. Most retailers had to run promotions to keep merchandise moving off the shelves. Foot Locker's gross margin dropped from 30.1% to 25.9% year over year, pushing its operating margin down to 3.3% of sales compared to 4.6% a year ago.
The good news is that Foot Locker is in a more flexible position heading into the key holiday shopping season. Inventory levels decreased 3% even though sales jumped 19%.
Challenges ahead
We believe we are well positioned to capitalize on evolving customer shopping behaviors through a sustained emphasis on digital as well as evaluating a further pivot off-mall, including through our Power Store offense. We believe our Power Store concept and community focus is the right offense to offset mall-related pressures.
-- Johnson
The list of potential pitfalls ahead is intimidating and includes a recession, reduced customer shopping traffic, and disrupted sports and back-to-school seasons. The lack of further federal stimulus support alone might cause a sharp decline in growth from the second to the third quarter.
Those challenges help explain why Foot Locker isn't prepared to reinstate any kind of short-term outlook. Investors should brace for volatile sales and profitability over the next few quarters.
On the other hand, the chain's reinstated dividend confirms that management sees the crisis period of COVID-19 as having largely passed. Foot Locker's main challenge now is adapting to changing consumer shopping habits by leaning on its online platform and its big-box "power store" format.
