Foot Locker: Are below average performances already taken into account?

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Investment thesis

Foot Locker’s (New York stock market :NYSE: FL) recent quarters have shown declining revenue and weak year-over-year growth. The company is coming off a strong 2021. But the company is struggling to maintain its competitive position. Some of its suppliers, in particular Nike (NKE), continue their direct-to-consumer campaign. I think that’s a significant headwind.

Foot Locker shares are trading at a cheap valuation. A regular dividend and a large redemption authorization promise high returns to shareholders. But I still think the investment is quite risky. For these reasons, I do not buy or hold stocks at this time.

Weak guidance and reversed trends

Foot Locker has struggled to generate significant growth for most of the past decade. From 2015 to 2019, the company only increased its turnover by 2% per year. The company’s profitability declined by almost 10% over the same period.

The company’s most significant growth spike came in 2021. Foot Locker reported a 12% increase in revenue and an 81% increase in profits over pre-pandemic levels. But it’s unclear to what extent Foot Locker’s growth was organic. Stimulus money was a major driver of consumer spending during the period. Some retailers have generated sustainable growth. Others benefited only temporarily from an increase in discretionary spending. A year later, we’re starting to get a clearer picture of how many companies are growing.

It seems that much of Foot Locker’s growth was based on the pandemic relaunch. The company reported a 9% decline in year-over-year revenue in the last quarter. The decline is even greater on a comparable basis.

Geographic distribution of Foot Locker revenue

Foot Locker Q2 2022 Results Slides

In North America, sales were particularly weak. The region saw a 16.1% drop in revenue year-over-year. These results were only partially offset by a strong increase in revenue from the APAC region. Unfortunately, these favorable APAC comparisons don’t really reflect organic growth. They were mainly driven by the closures in the region in early 2021.

Tips Foot Locker

Foot Locker Q2 2022 Results Slides

Foot Locker tips keep getting worse. The company now expects a 6% to 7% drop in sales. But this metric adds inorganic revenue from the company’s acquisitions of WSS and atmos in 2021. On a like-for-like basis, revenue is expected to decline 8% to 9%. By removing both brands’ contribution to 2021 revenue, core business revenue is expected to fall to pre-pandemic levels.

A pivot to omnichannel

Foot Locker faces significant headwinds. The company’s retail growth is stagnant at best. The company also faces increased competition between direct channels and consumer channels. Nike is investing heavily in e-commerce and its own retail presence. The manufacturer has even cut ties with a number of retailers in recent years. This is of concern due to Foot Locker’s exposure to Nike. Last year, the manufacturer supplied 70% of Foot Locker products.

In response to these trends, Foot Locker is trying to diversify its product lines. A key part of this is a pivot to an omnichannel model. The company is improving its online store and has set up a loyalty program. These online platforms are integrated with their retail stores. This allows the company to collect more data and increase the number of loyal customers. The company even allows sellers to dropship on its online store to increase product variety. On their last earnings call, management discussed online-only partnerships with certain brands.

Finally, we also continued to roll out our drop-shipping program across vendors and regions to provide our consumers with a seamless extension of choice and allow us to test new products and categories. One of the program’s partnerships that we’re most excited about is with Fanatics, a digital sports platform and global leader in licensed sporting goods. Starting this fall, our customers will be able to shop a much wider selection of their favorite fan gear online across major leagues and sports teams at footlocker.com, kidsfootlocker.com and champsports.com…as customers build their pride. outfits, they can also find a new pair of sneakers and other sportswear to complete the look.

But results from the company’s digital channels were mixed. Over the past two quarters, Foot Locker’s digital sales were down 25% year-over-year. That’s much faster than the rest of the business, which fell just 6% last quarter. Nor do these declines appear to be secular trends. In its latest report, Nike recorded 8% growth for its direct-to-consumer segment.

I think that’s the biggest risk of Foot Locker as an investment. The company’s competitive positioning is not good. The company will struggle to compete with vertically integrated manufacturers online. Currently, the company’s greatest strength is in its retail stores. This gap is slowly eroding.

Redemptions, Dividends and Valuation

However, the valuation of Foot Locker is very cheap. The company is trading at a forward P/E of just under 9 times. Its projected EV/EBITDA is just over 8x. This is normally within the range of what I would be willing to pay for a company with this profile. A low growth rate and a low moat can already be factored into this valuation. The company pays a decent dividend, yielding over 4%. Most recently, management authorized a $1.2 billion share buyback. That’s enough to buy one-third of the outstanding shares at the current valuation.

But I think this analysis is too simplistic. The company’s potential cash flow is not particularly high. The company expects to generate a midpoint of $400 million in non-GAAP net income this year. Management also guided $275 million in capital expenditures.

At the current rate, the company will need around $150 million to pay its dividend. It therefore seems unlikely that the company will have the cash to fully utilize its authorized buyout anytime soon. The company’s last quarter could prove it. The stock was at a 10-year low, but management only bought back $40 million worth of shares.

It is possible that the stock is undervalued. But I don’t think it’s a clear buy simply because of the current valuation. High returns would require improving company fundamentals, which I think is uncertain.

final verdict

Foot Locker is an interesting investment to analyze. The company already has a lot of pessimism in the stock price. But the company’s poor competitive positioning calls for caution. Even if the company is cheap, there are no obvious catalysts to cause the stock to reprice.

Foot Locker’s declining revenue and lack of a clear future are significant risks. Even with a margin of safety, the company could just trade at a discount for the rest of its existence, in my opinion. For these reasons, I do not recommend buying or holding at this time.

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