Foot Locker Stock: Why it has room to run (NYSE: FL)

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Foot Locker (FL)’s recent earnings report sparked a selloff after the company lowered its expectations for Nike (NKE) sales. While many worry about Foot Locker’s long-term prospects, I remain convinced that the company still has plenty of room for growth. Also, I think the recent selloff has brought the stock price back to a very attractive valuation.

The Nike case

Foot Locker, the popular retail company, is currently trading at $29.59 per share (as of last Friday’s close), down about 55.6% from its 52-week high. The panic started when Foot Locker released its earnings last week and mentioned that it planned to sell fewer products from Nike as a result of Nike’s DTC (direct-to-consumer) strategy plans. To be exact, Foot Locker announced that Nike purchases will not exceed 60% of total purchases in 2022. Comparatively, this metric was 70% in 2021, which is a drop of 10%. The news sparked a selloff, which saw Foot Locker’s share price fall to $26.36. I personally believe that Nike’s loss of business, while unfortunate, will not be a breaking point for this absolute powerhouse of a retail company.

The promising long-term prospects of Foot Locker

Other partnerships

Foot Locker currently still sells the products of many well-known brands. Brands like adidas (OTCQX:ADDYY), Crocs (CROX), Puma (OTCPK:PMMAF), New Balance, Under Armor (UAA) and Reebok all make the list. Also, it’s worth noting that Foot Locker hasn’t completely cut ties with Nike and will still sell a decent amount of Nike merchandise. Additionally, his investment in famed sneaker retailer GOAT could see the two embark on mutually beneficial long-term ventures. As such, we can see that the company still has plenty of options for its long-term growth and could certainly continue to innovate or integrate more brands. The company could also start looking into different product categories to make up for Nike’s loss of business. There are more than enough ways to recover from this minor economic “setback”.

Impressive earnings

Besides the disappointing news about Nike, Foot Locker actually showed great promise in their latest earnings report. Non-GAAP EPS of $1.67 means a decent 7.7% year-over-year growth. It also topped analyst estimates of $1.43. Sales were also up 6.9% year-over-year in the latest quarter, with total sales up 18.7% year-over-year. These statistics show that the company has recovered well from the hit of the pandemic, which has been particularly difficult for retailers, as revenues have had to be significantly reduced due to the inability of many stores to operate. The company also repurchased shares, with diluted shares outstanding falling about 1.2% from a year earlier. This is great news for investors who now hold a bigger slice of the pie.

Dividend increase

In its latest earnings report, the company declared a dividend of $0.40 per share, which is a whopping 33% increase from its previous dividend of $0.30 per share. This is great news for long-term holders of Foot Locker stock and could eventually attract many long-term investors.

Share buyback program

The company also announced in its latest earnings report that it was repurchasing up to $1.2 billion in stock. With a current market capitalization of around 3 billion, the value of this share buyback represents more than a third of the company’s current equity value. This is a huge buyout and could mean a significant increase in Foot Locker’s shareholder stake. Buying back such a large amount of shares would also most likely cause Foot Locker’s stock price to rise in the long run. Although the shares are not currently being repurchased, it is difficult to underestimate the magnitude of this share buyback. This is great news for the company’s current shareholders and could mean an incredible buying opportunity for those who don’t yet have a job.

Savings program

The company said in its last earnings report that it plans to launch a cost-cutting program, and cost-cutting is expected to result in an average of $200 million in savings each year. Such measures help the company maintain its profitability and also put it in a much healthier financial position if properly implemented. I am confident that the cost reduction program will contribute significantly to Foot Locker’s future finances.

Possible challenges

While there are plenty of reasons to be optimistic about Foot Locker’s future, the company may face a few challenges in the future.

Increased DTC implementation

With Nike’s aggressive move to DTC, where it sells its products directly to consumers, it’s hard to say if other big brands would follow in its footsteps. One thing we can’t ignore is that adidas, another of Foot Locker’s huge partners, has similar plans to move to a DTC strategy, and even expects DTC to make up half of its revenue by 2025. With more brands choosing to sell direct to consumers, wholesale partners like Foot Locker are hurting the most, and it’s hard to say if Foot Locker is able to get back on its feet if more brands decide to implement such strategies.

Supply chain concerns

It goes without saying that a company like Foot Locker is highly dependent on its supply chain, and there is no denying that the pandemic has severely affected global supply chains due to multiple lockdowns around the world. Since last year, Foot Locker has expressed growing concern over constraints in its supply chain. A reduction in manufacturing and a resulting decrease in inventory could seriously harm the company’s prospects, and it is uncertain whether the company will be able to fully recover and how long that recovery might take.

Valuation of FL shares

Metric

I ran a hedge on Foot Locker and used a simple 5 year projection analysis to estimate a fair price for Foot Locker. Below are the measurements I will be using.

Parameters I will use to estimate a fair price for Foot Locker

Metrics I’ll Use to Estimate a Fair Price for Foot Locker (Prepared by Author)

SPE (TTM)

EPS (TTM) represents Foot Locker’s current (latest 12 months) earnings per share, which stood at 8.61 at the latest earnings report.

Projected annual change in shares outstanding

I expect an average annual decrease of 5% in shares outstanding over the next 5 years, taking into account the massive share buyback program which I assume would have materialized to some extent.

Projected annual growth rate

I’m projecting an average annual earnings growth rate of 7% over the next 5 years, which is quite a conservative number, given that the company’s most recent annual EPS was up almost 180% from to the previous year. Although this number cannot be sustained and is largely due to a rebound from pandemic lows, an average annual growth of 7% seems like a reasonable estimate. Over the past 4 years, the company’s average annual EPS growth has been 63.7%, which is still a very high number compared to 7%.

Projected PER

I expect Foot Locker’s P/E ratio (TTM) to be 4, which is an increase from its current P/E ratio (TTM) of 3.44. I made this assumption because I expect investors to be willing to pay a higher price for Foot Locker once its future plans are implemented. As investor funds flow into Foot Locker, the P/E would likely see an increase.

Minimum annual rate of return

This metric describes the 5 year average annual rate of return you want to invest in Foot Locker. Given that the S&P500 has a historical average annual return of around 8%, I’m aiming a little higher at 12%, which isn’t too crazy but still beats the market by a decent measure.

Safety margin

I introduce a 10% safety margin, which means that I will reduce my real price target by 10% in case my assumptions do not materialize perfectly. Given my relatively conservative assumptions, I think that’s a fair margin.

Price target

Table containing stock analysis

Price target for Foot Locker based on 5 year projection (Created by author)

Based on my assumptions, I arrived at a price target of $31.88. This would mean that if my assumptions are correct, buying Foot Locker at $31.88 per share would generate, on average, annual returns of 12% over the next 5 years. With stocks currently trading under $30, that’s not a bad deal at all. Turbulent market conditions could see the stock price drop even further, giving rise to even better buying opportunities.

Conclusion

Although Foot Locker has some challenges ahead, I’m inclined to believe that this stock has good leeway and is definitely one to watch going forward. Under my relatively conservative assumptions, I arrived at a price target of $31.88. Based on today’s valuation, I would give this stock a ‘Buy’ rating.

James T. Quintero