Genesco (GCO) Proves Smaller Sales Can Still Mean Bigger Profits

On September 3, Genesco reported a second quarter that defied expectations. Revenue declined 3% to $530 million, but the company significantly reduced its adjusted operating loss and raised full-year earnings guidance to the high end of its range. This combination of shrinking sales and expanding profit highlights the footwear-first strategy gaining traction.

All three of Genesco's brands exceeded internal expectations, with Journeys leading the charge. The teen-focused chain reported its eighth consecutive quarter of positive comparable sales, up 2%. The company's 4.0 store format, featuring a more premium assortment, generated sales lifts of 25% or more in locations where it was introduced.

Journeys' success was further bolstered by a 180-basis-point expense leverage from better fleet management and staff utilization. Comparable sales continued to climb into August, marking Journeys' ninth straight month of positive comps and a mid-single-digit gain during the back-to-school period. Johnston & Murphy also reported a strong quarter, with comparable sales up 4% for the third consecutive period, driven by a multiyear partnership with Peyton Manning and a shift towards refined men's fashion.

Genesco's overall adjusted gross margin increased by 140 basis points to 47.2%, while the adjusted operating loss narrowed to $8 million from $14 million the previous year. The company also collected $22.5 million in tariff refunds and reduced total debt to $15.8 million from $71 million a year earlier, strengthening its balance sheet as it transitions into new leadership roles.

However, Schuh, Genesco's UK chain, saw a 9% decline in comparable sales due to a deliberate discounting restraint aimed at protecting margins. CEO Mimi Vaughn acknowledged the UK market's challenges and price sensitivity, and warned that the Schuh turnaround would take longer than the one underway at Journeys. Full-year sales guidance was revised downward to about 2% from the prior forecast of 1% to flat, reflecting the increased sales pressure expected in the second half of the year.

Third-quarter sales were projected to fall 4% to 4.5%, hurt by a $14 million exit of older licensed brands ahead of the Wrangler footwear launch and heavier marketing spend tied to back-to-school and Johnston & Murphy's new campaign. The company ended the quarter with 1,186 stores, down 5% from the prior year, and inventory expanded by 8% to $539.7 million.

Hedge fund ownership of Genesco rose to 20 funds from 15, indicating growing institutional confidence. However, short interest remained high at 10.85% of the float, suggesting a significant bearish sentiment. As of September 11, the stock traded at a forward price-to-earnings ratio of 13.87, a moderate valuation that did not fully account for the earnings recovery underway.

While Genesco's second quarter demonstrated its ability to generate profit despite falling sales, investors will need to monitor the company's progress over the next two quarters to see if this trend continues as it navigates the transition of licenses and faces a tougher UK market. The article suggests that while Genesco shows promise as an investment, other AI stocks may offer greater upside potential with lower risk.

The author acknowledges the potential of Genesco as an investment but believes certain AI stocks could be a better fit for those seeking high upside with lower downside risk.