Investors Should Sell This Footwear Retailer In A Recession, According To UBS

In a report released today, UBS says that it is less likely that Foot Locker can drive revenue growth in a recession than it is in a boom period. 

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As a result of his downgrade, Jay Sole has lowered his price target for the stock to $30 from $36 and downgraded it to sell from neutral. There is an implied downside of 25% based on Tuesday's close in the new target. The general consensus is that Foot Locker and several other softline stocks have not yet been priced in enough negative news, according to Sole. 

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In our discussions with investors, it appears that the market is currently too focused on recapturing margins and not enough on downside risks to sales, which are not adequately addressed in the market. The idea that a recession will significantly weigh on the sale of soft goods is still viewed as a bear case by many. In our opinion, this is a reasonable base case scenario," Sole said.

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We believe FL faces structural challenges because athletic brands like Nike are posing fierce competition. FL has closed Footaction, Eastbay, Runner's Point, Sidestep, Lady Foot Locker, and its Asia businesses in the past few years. Additionally, Champs is set to close many of its stores. As the market share shifts to brands, we anticipate this trend will continue.

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Moreover, UBS says Foot Locker's direct-to-consumer business will keep growing as Nike grows its direct-to-consumer business. 

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Nike's share of Florida's sales is forecast to fall from 70% to 55-60% over the next 12-18 months, according to Sole. "Nike's share is unlikely to return to 70% again in the future. In fact, we expect the share will decline further from 55-60%," said Sole.

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We believe Nike's top strategic priority is growing its direct-to-consumer (DTC) business, which conflicts with FL's relationship. In our view, Nike will be able to increase its direct-to-consumer business, which will motivate it to reduce the amount of inventory it allocates to Florida.

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It is likely that Nike will establish deeper relationships with some of FL's competitors, so it will be difficult for FL to remain competitive with Nike in the long run. There aren't enough other brands that can make up for more limited Nike allocations.

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Following Foot Locker's mixed fourth-quarter report, UBS downgraded it. Although the company beat analysts' earnings estimates, its full-year earnings guidance fell short.

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The shares of Foot Locker fell 2.6% during premarket trading on Wednesday. Shares have risen almost 6% this year and 27% since the beginning of the year.