Among the interesting trends I have been watching for most of the last two years, and that emerged, at least in part as a practical response to the global health crisis that has been a centerpiece of any practical economic discussion during that period, has been a shift in consumer focus towards health, wellness and fitness. Given the constant messaging about personal cleanliness, to encourage vaccinations and so on, I don’t think it has been too surprising to see people focus more on what they can individually do to boost their own immune systems to stay healthy. Over the last two year, the fitness aspect of this shift has offered some interesting opportunities for a value-oriented investor, but they haven’t come without some downside.
For most of us, exercise usually means going to the gym where we can find all of the equipment needed to pick and choose what to do in any given day. Based on my own personal observation in my own little corner of the world, that seems to mean that even as the economy reopens and community gyms are picking up capacity, people are also working out at home, and going outside to run, walk or ride.
Some of this shift is being seen in the sales numbers over the last few months for many apparel and shoe manufacturers, and even in sales at retailers, including big-box stores and specialty shops like Foot Locker (FL).
That doesn’t mean that these businesses are out of the woods; foot traffic at most brick-and-mortar stores and malls, which had been challenged by an increasing emphasis on e-commerce and direct-to consumer initiatives, generally remains significantly below pre-pandemic levels, which has put a lot of emphasis on these companies’ ability to rely on omnichannel marketing and distribution systems.
E-commerce has been one of a few different headwinds FL has been dealing with for a few years and has been lagging its competitors and even its suppliers. That includes big names like Nike Inc. (NKE) who are publicly working to drive direct-to-consumer relationships over traditional retail partners. FL’s specific reliance on NKE to stock its inventory has been signaled as a risk element, and for some have overshadowed FL’s intense capital investments in omnichannel marketing, sales and delivery that finally began to show positive growth in e-commerce in 2021, while management also put a lot of effort (and investment) into leveraging inventory management systems and supply chain management to increase productivity and efficiency.
While many of FL’s difficulties that pre-date the pandemic – decreasing mall foot traffic, supplier investments in competing, direct-to-consumer marketing channels – continue to present challenges, management’s efforts to develop their own omnichannel marketing programme and improve inventory and supply chain systems have helped FL improve a very solid fundamental profile consistently throughout most of the past two years and build a fortress-level balance sheet. The stock itself more than doubled in value from 2020 to 2021, driving from around $31 in October 2020 to a peak in May 2021 at nearly $67. Since then, the stock has dropped into a downward trend that really picked up momentum after the company’s earnings report. Immediate market reactions to earnings are often exaggerated by investor perceptions of management comments about future prospects or expectations. That begs the question of whether this latest plunge – the stock fell from around $40 per share to below $30 on an overnight basis, and has been hovering in that range since then – is another overreaction that contradicts the company’s fundamental strength? If so, the stock could be offering an even better value proposition than it has in the past. Let’s dive in.
Fundamental and Value Profile
Foot Locker, Inc. is a retailer of shoes and apparel. The Company operates through two segments: Athletic Stores and Direct-to-Customers. The Company is an athletic footwear and apparel retailer, which include businesses, such as include Foot Locker, Kids Foot Locker, Lady Foot Locker, Champs Sports, Footaction, Runners Point, Sidestep and SIX:02. The Direct-to-Customers segment is multi-branded and sells directly to customers through Internet and mobile sites and catalogs. The Direct-to-Customers segment operates the Websites for eastbay.com, final-score.com, eastbayteamsales.com and sp24.com. Additionally, this segment includes the Websites, both desktop and mobile, aligned with the brand names of its store banners (footlocker.com, ladyfootlocker.com, six02.com kidsfootlocker.com, champssports.com, footaction.com, footlocker.ca, footlocker.eu, runnerspoint.com and sidestep-shoes.com). FL has a current market cap of about $2.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased more than 7.74%, while revenues increased by about 7%. In the last quarter, earnings were -13.5% lower, while sales grew by 7%. The company’s margin profile had been showing impressive improvement through most of 2021, but has weakened as of the latest report; Net Income as a percentage of Revenues over the last twelve months was 9.97%, and declined to 4.4% in the last quarter. While many analysts dismiss FL (primarily due to its reliance on traditional stores, mall traffic, and NKE) I think the consistent improvement in its Net Income pattern under difficult conditions through most of 2020 and 2021 provided strong confirmation that the company’s investments in digital channels and improved internal systems are bearing fruit. This quarter’s decline appears to be attributable to supply chain shortages and challenges that have persisted as a plague to multiple sectors and industries throughout the pandemic. Whether that is a cyclical or chronic condition, however can only be determined by watching the company’s progress in the quarters ahead.
Free Cash Flow: FL’s free cash flow is very healthy, at $714 billion over the last twelve months and which translates to a Free Cash Flow Yield of 24%. This number has mostly held steady over the last quarter, but has declined over the past year, from about $903 million.
Debt to Equity: FL’s debt/equity ratio is .14, which is very low and marks a conservative approach to leverage. The balance sheet shows $451 million in long-term debt in the last quarter, which is significantly below the more than $2.8 billion they reported for the last quarter of 2019. Cash and liquid assets are very healthy, at about $1.4 billion. Their robust balance sheet, with next to no debt is a big indication of strength and marks a very interesting, positive shift under current market and economic conditions.
Dividend: FL’s annual divided was $.60 per share at the end of 2020, but was increased to $.80 per share in early 2021, $1.20 at the end of the third quarter, and $1.60 after their latest earnings report. That translates to a yield of 5.41% at the stock’s current price. It is worth noting that FL cut their dividend at the beginning of the pandemic from $1.52 per share in an effort to help preserve cash and boost their balance sheet; but the fact they continued to pay a dividend where many companies chose to eliminate it altogether, along with the recent increases is also a sign of strength. It should also be noted that their latest earnings announcement also included the announcement of a massive stock buyback program as a second leg of management’s effort to return value to their shareholders. Both the buyback and the dividend increases are significant signals of management’s confidence in their path ahead.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to worth with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term target at about $53.50 per share. That suggests that the stock is undervalued by about 81% right now. It should be noted that after the third quarter of 2021, this same analysis yielded a long-term target price at around $63 per share.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays FL’s price performance over the last year. The diagonal red line traces the stock’s decline from its May 2021 peak at around $67 to its recent low at around $26; it also serves as the baseline for the Fibonacci retracement lines on the right side of the chart. The most dramatic part of the chart, of course, is the overnight night drop at the end of February, when the stock dropped from a little below $40 to its $26 low overnight. Since then, the stock has been hovering in a narrow range, with current support at around $28.50 and immediate resistance at $31.50. A push above $31.50 can be expected to find next resistance at around $35, following the technical principle that gaps are often re-filled in the opposite direction of the gap by about 50% of its size. A drop below $28.50 should find next support around the stock’s 52-week low around $26.
Near-term Keys: FL’s current bearish momentum may have stabilized; it could also simply be consolidating for the near term and drop further if the market continues to be volatile and current conditions remain broadly bearish. While some of FL’s fundamentals have weakened and should rightly be considered as risk elements, the stock is also offering a discount that is very appealing; if you are willing to accept the possibility of continued volatility, and the possibility the stock could break down even further, I do think the stock’s dividend and general fundamental strength are worth considering. If you prefer to focus on short-term trading strategies, the stock’s current trading range could offer some useful signals. Use a break above $31.50 as a signal to consider buying the stock or working with call options, using $35 as a practical profit target. if the stock drops below $28.50, you could consider shorting the stock or buying put options, with $26 offering a useful, quick-hit profit target on a bearish trade.