As Foot Locker Inc. (FL - Get Report) surged 14.91% to $52.96 a share Wednesday afternoon after strong earnings and guidance, a Morgan Stanley analyst warned of key risks the sneaker seller may have a hard time out running -- falling margins and growing costs.
Foot Locker's financials appeared strong. The company reported adjusted earnings per share of 95 cents, beating Wall Street's estimates of 92 cents. Revenue also beat expectations at $1.86 billion, and so did comparable sales which increased 2.9% year-over-year -- higher than the expected bump of 2%.
The company also raised guidance for comparable sales for the fourth quarter, as Chief Financial Officer Lauren Peters said that growth could hit mid single digits. And, at a time when retailers are currently struggling with gross margins as tariffs have weighed on input costs, Foot Locker showed strength, too. Gross margin expanded to 31.6% from 31% in the year-ago period.
But Morgan Stanley analyst Lauren Cassel wasn't moved. She kept her underweight rating on the stock, and has a price target of $44 per share, roughly 16% below its current level.
"Bigger picture, margins continue to fall," Cassel wrote.
The year-over-year third quarter earnings-before-interest-and-tax margins declined -120 basis points, she pointed out, noting that elevated logistics costs and employee incentive compensation helped bring general and administrative costs to 21.4% of sales. Foot Locker saw those costs hit only 19.7% of sales in third quarter of 2017.
"We fear EBIT margins will continue to face pressure," Cassel said. "Our estimated -100 bps 2018 EBIT margin declines just the beginning."
Much of that concern is tied to sales growth. Many brands Foot Locker carries, such as Nike Inc. (NKE - Get Report) , sell directly to customers, cutting out middle men like Foot Locker. "Brands' direct to consumer efforts, a near-term fashion shift away from basketball shoes, and increasing industry competition could prevent comps from reaching that +4% level on a sustainable basis again," Cassel said. Plus, as a Goldman Sachs note out earlier this week pointed out, we could be at the peak of the economic cycle. Consumer spending could come down soon.
Cassel also said she's "slightly concerned if this is the sales and margin result FL delivers when 1) Nike is firing on all cylinders and 2) the US consumer spending environment is the strongest we've seen in eight years." She was referring to the 2.9% sales increase.
The Goldman Sachs note said that because it expects the economy to slow considerably, investors should be cautious on consumer discretionaries like Foot Locker. "we also remain underweight the Consumer Discretionary sector given its sensitivity to slowing economic growth."
Contrary to Cassel's point that direct-to-consumer selling could hurt Foot Locker, some on Wall Street have mentioned Nike's sales efforts in this area aren't working well, a misfortune that bodes well for Foot Locker, TheStreet's sister publication RealMoney points out.