INVESTMENT THESIS
Foot Locker Inc. (NYSE: FL). FL shares have started to recover, as digital sales grew 50% during the third quarter and comp sales rose at a double-digit pace in September and October. The company is also strengthening its marketing efforts. In 3Q, it launched several ‘digital storytelling’ campaigns, focused on the culture of basketball, that helped to boost demand for FL’s basketball sneakers. It has also introduced Klarna, a buy-now, pay-later program in North America. These programs increased sales by 9% from the prior year and management expects them to generate continued strong results post-pandemic. Management has signaled confidence in the near-term outlook by resuming dividend payments and stock buybacks. We believe that prospects for an earnings recovery make current valuations attractive.
RECENT DEVELOPMENTS
The beta on FL shares is 1.35.
Foot Locker recently reported fiscal 3Q20 results for the quarter ended October 31. Adjusted non-GAAP earnings came to $1.21 per share. The consensus had called for earnings of $0.63 per share. Third-quarter revenue rose 9% to $2.1 billion and included a pre tax non cash gain of $190 million related to a higher valuation in one of the company’s minority investments, Goat. The gross margin fell 120 basis points to 30.9%. Adjusted net income was $128 million, up 4.9% from the prior year.
In 2019, Foot Locker invested $100 million in Goat (‘Greatest Of All Time’), a secondary sneaker retailer that provides an authentication process for reselling sneakers. The deal is one of several investments that has helped FL extend its digital footprint. During the quarter, Goat completed a $100 million Series E funding round that will help it to expand globally. The funding approval led to an increase in the company’s valuation and to a noncash gain for Foot Locker.
On the social responsibility front, the company has donated $1.5 million of footwear (19,000 pairs of sneakers) to youth communities most affected by the pandemic.
During 3Q20, FL closed 95 locations (70 of which were discontinued Runners Point stores) and opened 27 new stores. The company is targeting 70 new store openings, 90 remodelings or relocations, and 210 closures for FY20. Approximately 10% of the company’s worldwide stores remain closed due to pandemic-related restrictions.
The company has not reinstated its full-year guidance, which it withdrew in March due to the pandemic.
EARNINGS & GROWTH ANALYSIS
Excluding exchange rate fluctuations, revenue rose 7.7%. Comp sales increased 7.7%, helped by strength in footwear and fleece apparel. Sales grew at a double-digit rate at the company’s Foot Action and Champs Sports subsidiaries. All other divisions posted single-digit growth except for Foot Locker Europe, Foot Locker Canada, and Eastbay.
On the expense side, FL’s gross margin of $648 million was 30.9% of sales, down from 32.1%. SG&A expense of $424 million rose 3.1% and was 20.1% of sales, down from 21.3% a year earlier.
FINANCIAL STRENGTH & DIVIDEND
Merchandise inventory decreased 9.3% in constant currency from the prior year to $1.19 billion. Total debt, including long-term lease obligations, was $2.6 billion.
Foot Locker has reinstated its dividend program, after suspending it in fiscal 2Q20. Our FY20 dividend estimate is $0.70 and our FY21 estimate is $0.60. During the quarter, FL repurchased 308,000 shares for $10 million.
MANAGEMENT & RISKS
Richard A. Johnson has been the president and CEO of Foot Locker since December 2014, and became the company’s chairman in 2016. He previously served as COO and as president and CEO of multiple Footlocker subsidiaries. Prior to Foot Locker, Mr. Johnson worked at Eastbay Inc. Lauren B. Peters joined Foot Locker in 2000 as the VP of Planning. She has since held roles of increasing responsibility and became the company’s CFO in 2011.
The company’s performance is dependent on overall economic conditions, and soft consumer spending and changing fashion trends could lead to lower-than-expected revenue and earnings. The company depends on traffic at malls where it operates its stores, and the spread of the coronavirus is a threat to mall traffic growth. The company also faces intense competition and its efforts to improve brand awareness and offer better merchandise could fail to achieve the expected results.
COMPANY DESCRIPTION
Foot Locker is an athletic shoe, apparel, equipment and accessories retailer with 3,100 stores in 27 countries within North America, Europe, Australia, Asia and New Zealand. Foot Locker also sells merchandise through its Eastbay direct mail platform. The company is headquartered in New York, NY and employs more than 15,000 people.
VALUATION
We believe that increased management confidence, signaled by the resumption of dividend payments and share buybacks, along with prospects for an earnings recovery, make current valuations attractive. Our target price is $42.
On November 25 at midday, BUY-rated FL traded at $38.83, down $0.10.
