The athletic sneaker market continues to be a passion for many consumers across the country, mostly teenage boys. There is even an online “stock market” for trading mostly high-end athletic footwear. One company that may benefit from these trends is the second-largest retailer of athletic shoes in the U.S., Foot Locker Inc. (FL, Financial).
The company operates 2,599 retail stores in 26 countries, including North America, Europe, Australia, New Zealand, Asia and the Middle East. Its brand portfolio includes Foot Locker, a youth culture brand comprising sneakers and apparel, Kids Foot Locker, which offers athletic footwear, apparel and accessories for children, and Champs Sports that operates as a mall-based specialty athletic footwear and apparel retailer.
It also has a comprehensive e-commerce offering through various websites and mobile apps. The company was formerly known as Venator Group Inc. and changed its name to Foot Locker in November 2001. The company was founded in 1879 and is headquartered in New York, New York. The current market capitalization is $1.8 billion.
Recent strategic actions
Foot Locker has made strategic efforts to improve its portfolio of stores. It purchased the WSS and Atmos brands while divesting Eastbay, Footaction and Sidestep. The company relies heavily on Nike (NKE, Financial) products, which represent approximately 70% of sales. The company is hoping to reduce that do under 60% over time.
The company also has opened its third new distribution center in the U.S., which should provide twp-day shipping cover for a significant portion of the U.S. market. Lastly, the company continues to transition to more off-mall locations with a larger store footprint.
Financial summary
The company recently reported second-quarter results for the period ending July 29, 2023, which showed a difficult operating environment. Total sales decreased 9.9% and same-store sales decreased 9.4%. These declines were primarily driven by driven by ongoing consumer softness, changing vendor mix, the repositioning of the Champs Sports brand, and higher levels of shrink.
Gross margin declined by 460 basis points as compared to the prior-year period which was driven by an increase in promotional activity, which included higher markdowns, as well as occupancy deleverage and higher shrink (theft). SG&A increased by 190 basis points compared with the prior-year period, with savings from the cost optimization program more than offset by underlying deleverage on the sales decline, inflation, and investments in store employee wages.
The company reported a net loss of $5.9 million, or 5 cents per share in the second quarter, compared to net income of $94 million, or 99 cents per share in the prior-year period. On a non-GAAP basis, net income was $4 million, as compared with $105 million in the prior-year period.
At the end of the quarter, the company's cash and cash equivalents totaled $180 million, while total debt on the balance sheet was $450 million. Working capital was a positive $919 million. Merchandise inventories were $1.8 billion, which was 11% higher than at the end of the second quarter last year but sequentially improved from the 25% increase at the end of the first quarter of 2023.
In a statement, President and CEO Mary Dillon said, "Our second quarter was broadly in line with our expectations, despite the still-tough consumer backdrop. However, we did see a softening in trends in July and are adjusting our 2023 outlook to allow us to best compete for price-sensitive consumers, while still leaning into the strategic investments that drive our Lace Up plan. Importantly, we are continuing to make progress on our inventory levels and look to best position the business for the upcoming holiday season and into 2024."
Valuation
Current analyst consensus earnings per share estimates for the 2023 fiscal year ending January 2024 are $1.34. The company is definitely not earning up to normal capacity levels due to current operating issues. The company earned $4.95 last year and $7.25 the year before that. For fiscal year 2024, earnings are expected to improve to $2.15.
Even with these depressed earnings, the stock is selling at approximately 14 times current fiscal year earnings and 9 times next year's earnings. The enterprise value/Ebitda ratio is approximately 7 on a forward-looking basis.
The GuruFocus discounted cash flow calculator creates a value of $29 when using more normalized forward earnings per share of $2.15 and a 10-year growth rate of 6%. Returning to the stock's 52-week high of $47 would require a 10-year growth rate of approximately 13%.
There are 14 analysts with current ratings on the company with and average price target of $19.54, including a high target of $30 and a low target of $15.
The company had been paying a dividend, but now is pausing the quarterly cash dividends beyond its recently approved payout on Oct. 27.
Summary
Foot Locker represents a potential interesting opportunity for contrarian investors. If it can regain its former earnings power, then the stock is substantially undervalued. However, the slowdown in current consumer purchasing trends cannot be ignored.
Tailwinds may include a successful shift to more digital sales as well as replacement of certain Nike products from other brands.
