Addressing Foot Locker's Recent Cliff Dive

When any company has their stock drop over 30% in a few weeks, the obvious question is "why?" What happened? Did a competitor outbid them on an acquisition? Did their cash flows hemorrhage? Was the company put under investigation?

Well, it seems some are asking “why” regarding Foot Locker Inc.’s (FL, Financial) recent drop from $70 per share to $58 per share on May 18 and more recent trading around $48 per share. Is it a heightened threat from Amazon (AMZN, Financial)? Is it poor management? When this sudden drop occurred, my initial reaction was Foot Locker is a retail store struggling like the rest and must have fallen victim to online shopping. That is until I had read an excerpt from Foot Locker CEO Richard Johnson regarding the company’s latest earnings:

“The first quarter was one of our most profitable quarters ever, but it did fall short of our original expectations. The slow start we experienced in February, which we believe was largely due to the delay in income tax refunds, was unfortunately not fully offset by much stronger sales in March and April.”

The actual earnings were reported to be $1.36 per share versus the predicted $1.38 per share; hardly a catastrophic miss. Revenues had also reportedly increased from last year to approximately $2 billion, up from $1.9 billion. The question that should be asked is whether or not this selloff is justified and is this a buying opportunity for value investors? Can you buy this stock and feel comfortable this is a low-risk investment in an industry feeling the heat from Amazon and other retailers?

If you compare Foot Locker to other retail stores, you will realize it is not your ordinary retailer. Take, for example, Nordstrom (JWN, Financial), Macy's (M, Financial), Kohl’s (KSS, Financial), JC Penney (JCP, Financial) and Sears (SHLD, Financial). Without looking, how do you think Foot Locker’s financials measure up to these retail stores? Is it a fair comparison? Interestingly, Foot Locker either comes out on par or well ahead. In fact, it is difficult to find many consumer- based brick-and-mortar stores stronger than Foot Locker. To help illustrate this, I have compiled a small table of notable financials from Foot Locker versus the retailers just mentioned.

While the above table paints a very strong and compelling picture for Foot Locker, the most intriguing numbers to me are the PEG ratio and Peter Lynch earnings line.

First, the PEG ratio (defined as the price-earnings (P/E) ratio divided by the growth rate of the company) is often used as a way to compare companies to one another when the growth rates differ. Normalizing for growth when comparing retailers is essential given the revenue trends differ so greatly from one retailer to another. When the ratio is equal to 1, the stock is considered to be fairly valued. Foot Locker is currently well below this. It should also be mentioned this undervalued conclusion agrees with the Relative Strength Index (RSI), which is a momentum oscillator measuring the speed and degree of change a stock price is experiencing. This helps determine if a stock is oversold or overbought. A value above 70 is commonly considered overbought while a value below 30 signifies oversold. Foot Locker has a current RSI of approximately 17.

The second intriguing number regarding Foot Locker’s financials is the Peter Lynch earnings line; a superimposition of a stock’s price with a line that is 15 times the trailing 12-month earnings. Up until the sudden selloff, this earnings line correlated very closely to the actual stock price. This sudden selloff illustrates just how far below the current stock price of Foot Locker is to this earnings line; a difference which has simply not been seen before.

Examining Foot Locker from yet another perspective and charting the revenue (with estimate), along with the stock price and earnings per share further illustrates just how drastic this recent selloff was. The takeaway seems obvious; Foot Locker continues to grow, is financially strong, is run well and has a positive future.

Taking this quick analysis of Foot Locker 's financials into account with a recent dividend increase (27.5 cents to 31 cents), a three-year $1.2 billion common share repurchase program extending into 2020, plans to expand stores globally as well as update existing stores, it is difficult to find any reason to not take Foot Locker very seriously when it comes to long-term stability and growth. This is further bolstered by the fact a majority of analysts have given Foot Locker a “Strong Buy” recommendation.

I believe it is fair to say Foot Locker’s strong financials are so abnormal for a brick-and-mortar store you cannot help but ask yourself, “What makes Foot Locker so different?”

While this is arguably up for debate, one of the key drivers for this success is Foot Locker carries products which are subject to strict control regarding supply and are in high demand. In other words, the shoes being sold are not your typical “shoe.” In some cases, when new shoes go on sale it is not uncommon for them to sell out right away (both online and in-person) and this drives customers straight to Foot Locker’s doors to beat the crowds. Foot Locker has even developed a calendar stating where and when certain shoes will be released. This approach to engage customers is an ingenious way to bring them physically into the store and keep overall demand high. Combining this approach with an ever-expanding online presence, Foot Locker has control over how it sells to its customers in an incredibly sophisticated fashion.

Lastly, I believe it is fair to say Foot Locker is simply not your normal brick-and-mortar retailer. It has done an excellent job of responding to the ever-expanding Amazon threat and has shown there remains a need and desire to have a heavy physical presence to accommodate customers.

Disclosure: I am long FL.