Finish Line Posts Weak Earnings but Here’s Why You Might Still Want to Bet on It

With the market modestly up in early morning trade, Finish Line Inc (NASDAQ:FINL)’s stock slumped by over 16% amid disappointing financial results for the second quarter of fiscal 2015. The athletic shoe and apparel retailer reported EPS of $0.57, in line with expectations, but its revenue of $483.2 million missed the estimates by $7.64 million. The company’s gross profit margin slipped by 0.2% on the year to 33%, while SG&A expenses increased by 0.4% to 24.4%. Operating margin expanded by an annual 0.6% to 8.6%. However, our data from the latest round of 13F filings suggest that hedge funds are bullish on Finnish Line, therefore they see a potential for the company in the long-run.

We mention the hedge fund activity concerning Finish Line Inc (NASDAQ:FINL) because our research has shown that historically their stock picks delivered superior risk-adjusted returns. This is especially true in the small-cap space. The 50 most popular large-cap stocks among hedge funds had a monthly alpha of about six basis points per month between 1999 and 2012; however the 15 most popular small-cap stocks delivered a monthly alpha of 80 basis points during the same period. This means investors would have generated 10 percentage points of alpha per year simply by imitating these small-cap ideas. We have been tracking the performance of these stocks in real time since the end of August 2012 and our approach managed to beat the market by 60 percentage points (118% return vs. the S&P 500’s 57.6% gain) over the last 36 months (see more details here).

In a worrying development, Finish Line Inc (NASDAQ:FINL)’s consolidated inventories increased by 11% year-over-year to $366.3 million, while guidance is weaker than it was expected, with the company saying that it forecasts “earnings per share to increase in the low single to mid single digit range over fiscal year 2015 non-GAAP diluted earnings per share of $1.67”. This compares to the consensus 2016 EPS expectation of $1.80 per share. Although shares trade at a forward P/E of under 12, analysts EPS estimates will decline and Finish Line’s forward P/E will rise because of management’s lower guidance. Fueled by today’s decline, the stock Finish Line is down 10% year-to-date.

The bull case for Finish Line isn’t discredited, however. Finish Line inventories increased significantly because the company anticipates stronger next quarter sales, not because its demand is weaker by double digit percentage points. Finish Line repurchased 167,000 shares in the second quarter and still has 4.8 million shares left in its board authorized repurchase program. One bad quarterly earnings report doesn’t make a trend and Finish Line’s fundamentals could rebound. Finish Line will benefit from China’s currency depreciation because its costs will be lower. The macro environment for Finish Line is strong, with the U.S. unemployment rate at 5.1% in August and trending lower.