Morgan Stanley Picks Nike Over Foot Locker, Says Brand's Growth May Not Translate To Retail Partner

Following the investment mantra of brands over retailers, Morgan Stanley named Nike Inc (NYSE:NKE) a top pick this week. 

The Analyst 

• Morgan Stanley analyst Lauren Cassel initiated coverage of Nike with an Overweight rating and $88 price target.
• The analyst initiated coverage of Foot Locker with an Underweight rating and $44 price target.
• Morgan Stanley also initiated coverage of Skechers with an Equal-Weight rating and $28 price target.

The Thesis

With many apparel brands directing their focus on direct-to-consumer sales and away from undifferentiated retail, Morgan Stanley said it's opting for brands.

Athletic footwear brands are preferred over apparel stocks given innovation-led pricing power, direct-to-consumer mix shift, strong brands and a near Nike-Adidas duopoly, Cassel said in the initiation note. 

“We also prefer to own the brands that drive innovation in the category and are experiencing a sales and margin lift from DTC growth vs. those who simply curate other people’s goods." 

Nike: A Tech Company?

When Nike was struggling, the company's ethos was largely focused on innovation. Now that the brand has regained positive momentum, the analyst said company is positioned to take share in the high-growth global activewear market and increase profitability, making it one of the few big winners in the shift to e-commerce.

“We believe NKE is in early innings of transitioning from a traditional wholesale business to an emerging retail technology company." 

A Disconnect With Retail

Nike’s role in e-commerce comes at the direct expense of Foot Locker, Inc. (NYSE:FL), the brand's largest retail partner, according to Morgan Stanley. 

Nike products represent 67 percent of Foot Locker’s merchandise, but the brand's return to growth might not translate to its retail partner, Cassel said. 

Forty-six percent of Nike.com products are not available on FootLocker.com, possibly meaning that Nike is keeping the good products for itself. 

“Plus, FL’s top 10 percent of customers represent a high percentage of its sales and our AlphaWise survey shows 34 percent of 15-to 24-year-olds prefer to shop through brands’ stores or online. If these core customers increasingly shop directly with Nike, FL could experience outsized sales declines."

Skechers: Revenues Are Growing, Earnings Are Not

Skechers USA Inc (NYSE:SKX)'s revenue growth looks appealing, but its margins do not, Cassel said. 

The analyst forecast high single digit to low double digit annual revenue growth for the sneaker maker over the next five years fueled by international business, but remains skeptical of Skechers' earning power. 

Skechers' management incentives are "misaligned" with those of shareholders, Cassel said. 

“The stock’s negative 27 percent YTD move makes us more positive near-term, but we’ll remain on the sidelines until we see signs of consistent execution and operating income growth." 

Price Action

Nike shares were trading up 1.55 percent at $78.73 before the close Thursday, while Foot Locker shares were nearly flat at $47.82 and Skechers was up 1.08 percent at $28.03. 

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Public domain photo via Wikimedia.