Dick's Sporting Goods has faced challenges fixing Foot Locker since acquiring it last year. Some skeptics are asking: 'Why buy it in the first place?'

Dick's Sporting Goods, which owns Foot Locker, reported quarterly results on Tuesday.

The record sell-off of Dick's Sporting Goods shares this week wasn't just about recent flatlining sneaker demand at Foot Locker. To investors, Dick's results were proof that years-long anxieties about the shoe retailer were justified.

Analysts say Foot Locker, which Dick's $(DKS)$ bought in September for $2.5 billion, had long struggled with the decline of shopping malls in the U.S., as well as with competition, cautious consumers and stumbles by Nike. By Tuesday, after months of skepticism over the acquisition and Dick's bleak second-quarter results, investors had had enough, sending Dick's stock 30.7% lower.

"It kind of confirmed investors' hatred of this acquisition," Morningstar analyst David Swartz said about the sell-off. "People had a very negative view of it from the very beginning."

Dick's on Tuesday said sales at its namesake stores remained strong, with sports gear outside of sneakers helping deliver a 4.9% same-store sales gain, and also said it was confident in Foot Locker's long-term potential. Still, same-store sales at the shoe chain likely fell 3.6% during the second quarter, based on adjustments factoring in the timing of the acquisition.

And after initially expecting gains in Foot Locker's same-store sales and an operating profit, management now expects those sales for the year to be anywhere from flat to down 2%, with an operating loss between $40 million and $80 million.

Foot Locker is dealing with challenges facing the broader athletic-shoe industry - namely, consumers who are too worried about affording basics to think about buying less essential items like sneakers, D.A. Davidson analyst Michael Baker said in a research note on Tuesday. For more bearish investors, those issues raised questions about whether turning around the business is realistic.

"It's not about managing [Foot Locker] better," Baker wrote, "it's about 'why buy it in the first place?'"

Foot Locker was once ubiquitous in shopping malls

In past decades, investors probably would have found more to like. Foot Locker, which opened its first store in 1974, expanded as shopping malls opened across the U.S. through the 1980s. The company launched Lady Foot Locker and Kids Foot Locker, and the popularity of athletes like Michael Jordan - and in turn Nike $(NKE)$ - carried it through the 1990s.

But by the 2000s, more people were shopping online or at rival sportswear chains or department stores. Mall traffic suffered, and so did Foot Locker. Closures and cost cuts followed.

Foot Locker also became too dependent on Nike, which made up more than three-quarters of the chain's sales, Swartz said in an interview. Then, several years ago, Nike began selling more gear itself - including some of its hottest items - potentially steering sneakerheads away from Foot Locker and toward Nike's own stores and platforms like StockX, Swartz said. When Mary Dillon, a veteran of Ulta Beauty $(ULTA)$, became Foot Locker's new CEO in 2022, some analysts wondered why she would want to go there.

When Dick's bought Foot Locker last year, the move had the potential to increase Dick's customer base in urban areas, where Foot Locker stores were concentrated, complementing Dick's stores in the suburbs.

In December, Edward Stack, Dick's executive chair, said that turning around the sneaker chain would be hard work. But, he said, in a way it would also be "simple."

"The previous team that was running Foot Locker really got away from retail 101, to have the right product, the right place, the right store," he said. "They didn't have the right product, they didn't have access to the right product. We'll have access to that product. We'll have it in the right stores."

But Dick's results on Tuesday showed that the right product had yet to arrive at Foot Locker. Management said there was still more industrywide discounting for sneakers - a sign of weaker demand - and too many "legacy" and retro sneakers sitting around unsold. Some new shoe launches also didn't go as well as executives had hoped. Foot Locker, the company said, was more exposed to those issues.

Nike's woes are fueling pain at Foot Locker

Nike's current woes are behind the pain at Foot Locker, and thus at Dick's, Truist analysts said in a note on Wednesday. Nike has been trying to sell off its surplus of casual lifestyle sneakers, like Dunks and Air Force 1s, after pushing them for years and eventually driving them out of style.

"We had previously been more optimistic that the 'cleaning out the garage' phase of the Foot Locker turnaround was nearing completion," Truist analyst Scot Ciccarelli said in a note on Wednesday, "but [Dick's] appears to have materially underestimated the clearance activity required to restore inventory health."

Oppenheimer analysts, in a note on Wednesday, also highlighted the difficulties at Foot Locker. But they called out some positives - noting that management said it sees few signs of bargain-seeking at Dick's namesake stores, and that demand for footwear and clothing geared more toward athletic activity at those stores was holding up. They said they were upbeat about Dick's ability to get Foot Locker back on track.

While they slashed their price target on the stock to $150 from $270, they kept their outperform rating and said shares of the company were "too cheap to dismiss."

During Dick's earnings call on Tuesday, Chief Financial Officer Navdeep Gupta said the company was expecting to book pretax charges of up to $750 million to clean up Foot Locker. He said the company had recognized $516 million of those charges, with the rest to be taken through the year and "over the medium term."

Stack said the company was still trying to fix problems created by Foot Locker's old management.

Dick's is reinvesting in marketing the shoe chain, he said, noting that Foot Locker hasn't had a big public-facing marketing campaign since around 2013. Dick's is also trying the change the format of Foot Locker from a wall of sneakers to clearly defined shoe categories.

"We're going to go through some pain, and every once in a while, an industry has to go through a little bit of pain to reset," Stack said.

Over recent quarters, Swartz said, investors seemed more willing to embrace a bit more pain, and the stock occasionally trended higher over the spring and summer. But largely as a result of Tuesday's sell-off, shares of Dick's are down around 33% so far this year.

"There was a complete reversal, where people said 'Oh boy, we were right, Dick's blew it, they made this terrible acquisition,'" Swartz said. "There's a long and sad history of retailers making poor acquisitions."

-Bill Peters