UK retailer JD Sports Fashion has performed well in 2021, with recent trading updates ahead of expectations for sales and profitability. Other sports fashion retailers haven’t shared JD’s enthusiasm, however, with recent results from Foot Locker pouring cold water over sports retailers’ shares. Are the challenges seen by Foot Locker likely to affect UK market darling JD? Read below to find out more.
Foot Locker Results
It’s fair to say that the market was unimpressed with Foot Locker’s recent earnings release in late February as the shares were walloped -35% on the day, leading to a 55% decline in total from recent highs seen back in the summer of 2021.
The results for fiscal 2021 were pretty good in themselves. Total sales grew 18.7% and earnings grew 179%, boosted by a return to normal trading activity and from direct stimulus checks the US government handed to citizens across the year.
However, as is often the case, the market was more concerned with other factors than the poor guidance mentioned in the 2021 numbers. The concurrent damage to Foot Locker’s stock was predominantly due to the Nike direct to consumer (DTC) initiative, where Foot Locker’s predominant supplier has begun to reduce the flow of stock to the retailer.
Beginning in the fourth quarter 2022, Foot Locker, Inc. does not expect any one vendor to represent more than 55% of total supplier spend, down from 65% in the fourth quarter of 2021. As a result, no single vendor is expected to represent more than approximately 60% of total purchases for fiscal 2022, down from 70% in 2021, and 75% in 2020. This change reflects the accelerated strategic shift to DTC by one of the Company's vendors and Foot Locker, Inc.'s ongoing brand and category diversification efforts.
As I have documented in the past, 'key supplier risk' is one of the main concerns for the Sports Fashion industry, which is typically reliant on two mega brands, Adidas and Nike, for the lion’s share of sales. With both Adidas and Nike looking to prioritise their own DTC channels, such as Nike’s online ‘SNKRS’ app, this leaves the sportswear retailers at risk of losing stock to the manufacturers.
So, with Foot Locker reporting supply restrictions from Nike, how did the business end up in this position, and how likely is this to be of concern for JD sports?
My first point of call is to understand whether JD Sports is a preferred retailer for Nike, thus insulating them from the troubles at Foot Locker and second, to try to grasp Nike’s point of view on the various strategic partners it looks to do business with. Below, I have compiled commentary from Nike with regards to its Strategic Partners over its last few earnings calls.
NIKE Direct grew 25% on a currency-neutral basis and wholesale grew 6% in the quarter, led by strong double-digit strategic partner growth in JD Sports and Zalando (Q2 2021)
We know that our consumers want a consistent, seamless and premium experience. And so alongside our strategic partners, we continue to consolidate the marketplace to give our consumers that premium experience.
We're leaning in with those partners that see the world the same way we do [...] And the good news is, those are the partners that have the most robust business with our shared consumers today. So the consolidation will continue. (Q3 2021)
Today, we're working closely with large strategic partners like Dick's Sporting Goods, Foot Locker and JD Sports, as well as compelling local neighbourhood partners who are authentic to sport performance and lifestyle. Together, we are driving change to create a new more connected and seamless experience for consumers around the world, which is exactly what consumers want. (Q4 2021)
I also enjoyed visiting a few strategic partner doors, including DICK's and Foot Locker. What's clear across the marketplace, both owned and partnered, is how online to offline is becoming second nature. We know that higher levels of connectivity across physical and digital are driving better consumer experience and loyalty. (Q1 2022)
What I would tell you is that we continue to see strong growth in our differentiated partners because of the fact that they are creating a better consumer experience and driving more demand. Their weeks of inventory on hand is about half where they would like it to be right now because of the strong demand that they're driving. And to take it a step further, over the last three years, we've actually exited about 50% of our undifferentiated accounts, while we've been able to deliver strong double-digit growth. (Q1 2022)
We announced a partnership with one of our strategic retail partners, Dick's Sporting Goods, who shares our vision for the future of retail specifically, shopping and experiences that are amplified by digital and personal to each consumer's journey. This new partnership allows shoppers to link their Nike member account and their DSG account together to unlock exclusive offers, products and experiences.
Recently, I had an opportunity to visit one of DSG's newest concepts, the House of Sport door in Rochester, NY. I must say I was blown away at the store's unique service model, interactive sports experience and enhanced showcasing of product, which creates a true destination for consumers and will alter future expectations at retail. Our partnership with DSG is a new model for how brands and retailers work together delivering product, experience and connection service to delight consumers at scale. We are fulfilling our vision, that through connected member experiences and inventory, powered by connected data and technology, we can provide consumers with greater access to the very best of Nike with more speed, convenience and connection to our brand and sport than ever before. (Q2 2022)
Looking at recent transcripts, we can certainly answer a few questions as to Nike’s relationship and future intentions for wholesale suppliers. Nike has already cut 50% of its wholesale accounts and intends to shift its retail account mix to those that add the greatest value to the brand and share Nike’s vision.
It is also clear that it is possible to impress Nike’s management team as a retail business, as Dick’s Sporting Goods managed to do in Q2 2022, and that Nike sees value in premium retail offerings. Dick’s Sporting Goods seems to be Nike’s favourite retailer in current times, and it has been called out in pretty much every earnings call over the past 18 months. Recently, Dick’s signed new partnerships with Nike, as seen in the commentary in the Q2 earnings call.
The extent to JD and Footlocker’s favourability for Nike is somewhat unclear when looking over commentary from Nike’s recent earnings calls. They have both been mentioned in equal amounts over the last 18 months.
Regardless of specific mentions, it is also clear that Nike’s DTC is becoming more and more important to the business, as it is receiving increased levels of airtime on earnings calls versus the mentions of ‘strategic partners’, which have taken a backseat over the last three quarters.
Is JD Sports next to come under pressure from Nike?
Footlocker’s pain isn’t currently being felt by JD (or other retailers such as DSG). However, the company is certainly aware of the risk. Within JD’s annual report, key suppliers are listed as a business risk. Peter Cowgill, JD’s founder and CEO, has also alluded to the risks posed by Nike and Adidas’ DTC ambitions in many interviews. As an argument in JD’s legal battle over the ownership of Footasylum, challenged by the competition markets authority, JD Sports argued it faces much greater competition from brands like Nike and Adidas selling directly to consumers, and that the merger will help both Footasylum and JD compete.
Nike has been championing its own retail sales for years and currently has 1050 retail locations globally (325 in the US and 725 internationally). Whilst Nike does not break out international stores by location, revenue figures would suggest that Nike’s own brand stores are located in Western Europe, China and developed countries in Asia. These stores compete directly with JD and other retailers. Although a global physical retail presence has helped Nike reduce its reliance on wholesale retail partners, a major accelerant to Nike’s DTC gains has been garnered from the increasing adoption of eCommerce as a consumer shopping channel.
The eCommerce channel for Nike allows significant advantages in deploying its DTC strategy. eCommerce is a cost effective method of expanding into new or existing markets. Nike already has significant distribution capabilities and eCommerce allows Nike to leverage its existing assets. The ability to fulfil customer orders without bricks and mortar store costs increases Nike’s ability to spend more on customer acquisition (to own brand websites) and increase overall purchase volume (through the direct channel) at the expense of retailers such as JD.
Where eCommerce provides such leverage to Nike, it is pivotal to understand the fundamentals of eCommerce when considering if JD will come under increased pressure from Nike. With this in mind, there are some important questions to consider:
What is the overall eCommerce penetration in JD’s markets?
Are customers likely to purchase items from JD (or other retailers’) online stores if the same product is available on the DTC website (Nike/Adidas)?
Can a retailer actually add value through the online channel?
To help answer some of these questions, we can look at the eCommerce penetration rates for various geographies across the world. It is fair to say that the UK and US are well penetrated in terms of eCommerce sales, which likely aids Nike and other suppliers in using their own DTC channels.
Given JD makes 41% of sales in the UK and 29% of sales in the US, two markets with high preference for eCommerce sales, one could infer that JD is already proving customer loyalty to its retail websites over Nike’s or Adidas’ own brand platforms.
A second inference we can also make is that due to generally low eCommerce penetration in other geographies important for footwear retail, such as Spain, Italy and other European destinations, manufacturers such as Nike will value JD’s physical retail presence where many consumers are not yet acclimatised to shopping for footwear and clothing on the internet.
A quick look at the Nike and JD websites show the complications of the above questions playing out in real time.
Above you can see a popular trainer release – the Nike Air Max 97 SE – listed on both JD and Nike’s websites (Nike offers a £0.05 discount to JD). JD’s listing is with full stock in every size format. Nike has sold out of stock in all popular sizes.
Listings such as this suggest Nike is directing stock to JD at the behest of its own DTC operation. In situations where Nike is aware it will be selling out of various shoe concepts, will it continue to sacrifice its own operations to benefit retail partners such as JD?
What is JD doing to combat the DTC threats from key suppliers?
In JD’s annual report, the below mitigation measures are mentioned when considering the risks of key suppliers:
The Group seeks to ensure it is not overly reliant on a small number of athletic brands by constantly adding new brands to its offer and by offering a stable of evolving private labels. Where possible, the Group’s retail fascias also work in partnership with the third party brands in their business on the design of bespoke products which is then exclusive to the Group’s fascias. Furthermore, the Group continues to actively seek additional brands which it can either own or licence exclusively.
Whilst the above commentary goes some way to explaining JD’s mitigations, I believe it doesn’t disclose the full details behind JD’s defence strategy, and to some extent, the above strategy alone is fairly limited in its applicability, given the dilutionary effect to brand equity that retailers face when deploying too much private label stock (the primary reason behind Nike’s refusal to stock UK retailer Sports Direct).
In my opinion, JD’s main strategy in the DTC war with key suppliers has been aggressive, acquisition-led expansion. JD made a big splash in 2018 with the purchase of Finish Line, a 500 store retailer in the US. However, in the years 2020 and 2021, JD made a total of 5 headline acquisitions (excluding the contested Footasylum):
Cosmos Sport (Greece) - 50 stores
MIG (Poland) - 410 stores
Deporvillage (Spain) - Online
Shoe Palace (USA) - 167 stores
DTLR (USA) - 247 stores
Rather interestingly, looking at the above, JD’s geographical focus has been to expand in Europe, with the acquisitions of MIG and Cosmos offering a vast physical retail presence in markets that are typically under penetrated with eCommerce sales.
By adding just under 1000 retail sites in two years, JD looks as though it is supersizing its physical retail presence to aid its negotiating power with the key suppliers.
In 2021, JD also took a step to add some footwear brand experience to the board of directors. JD appointed Bert Hoyt, ex-Nike executive, to the board of directors. Bert brings experience as a vice president of Nike and had previously been a general manager at sports fashion business Puma. This hire significantly improves the management team experience at JD, which has typically relied on Pentland Group executives as board members.
JD’s Latest Results
Despite concerns from key suppliers, JD’s results continue to look encouraging. Sales in 2021 are expected to grow 35%, boosted by the acquisitions made across the year. JD’s latest trading update disclosed growth of 10% on a like-for-like basis at current fascias.
The re-opening of stores and return to normal trading circumstances is forecast to lift the operating margin back towards JD’s target of c.10%.
The below statement was provided by JD on the 17th of February:
‘In the trading update on 12 January 2022, the Group announced that total revenues for the twenty-two week period to 1 January 2022 in the Group's like for like businesses were more than 10% ahead of the same period in 2020 with an equally positive performance across the Black Friday and Christmas period. This positive performance continued into January and, as a result, full year results are expected to be slightly ahead of previous expectations. Headline profit before tax and exceptional items for the year ended 29 January 2022 is now expected to be at least £900 million.’
JD’s recent results display a business that continues to fire on all cylinders. JD’s brand in core markets continues to resonate with customers and like-for-like sales growth of 10% in 2021 shows that JD is far from just an acquisition vehicle.
Whilst JD’s medium term outlook is good, long term risk from Nike and other sports brands’ intentions to boost their own DTC channels is significant, but is being managed.
JD is likely better positioned than most sports retailers, with best-in-class retail propositions (read earlier article on ‘cool factor’), physical retail presence in under penetrated eCommerce markets and a continued intention to grow its store estate, which will improve its purchasing power with key brands.
With JD trading at a forward P/E of 13 and with a free cash flow yield of 10%, I believe the long-term risks are priced in. I think this price reflects an attractive opportunity to purchase a leading retailer.
At the time of writing, James owned shares in JD Sports.
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