FL is down about -14% from its yearly peak. Is it a good value?

One of the simplest concepts a lot of successful investors have used to find useful investments is to start by looking around their house.

Regular household items, including what you wear, can offer an interesting outlet to find practical investments, often at useful, discounted prices. One of the trends that I’ve followed with interest for the past three years is the general shift towards personal health and wellness that saw a boost beginning in 2020 from the pandemic. That includes fitness and exercise. 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, even as many people headed back to the gym, others are also working out at home, and going outside to run, walk or ride.

From 2020 through much of last year, a lot of the companies that focus on health and wellness, including footwear and apparel companies like Foot Locker (FL) saw that shift provide significant tailwinds that propelled their businesses through the worst of the pandemic and that many were able to leverage to set up a solid footing for the future. That doesn’t mean that these businesses are out of the woods; foot traffic at most brick-and-mortar stores and malls, which have been challenged by an increasing emphasis on e-commerce and direct-to consumer initiatives, generally remains significantly below pre-pandemic levels, putting continued 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 focusing on 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 has 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 continue to present challenges, management’s efforts to develop their own omnichannel marketing programme and improve inventory and supply chain systems helped FL improve a very solid fundamental profile consistently through 2020 and 2021 and build a fortress-level balance sheet that remains solid now, even as inflationary concerns have increasingly added complexity to the company’s transformation efforts. The stock itself more than doubled in value during that time, driving from around $31 in October 2020 to a peak in May 2021 at nearly $67. After that, the stock dropped into a downward trend that bottomed in July of 2022 at around $24 per share. Since then, the stock moved into a new upward trend, pushing to about $47.50 at the start of February. The stock has dropped back from that point over the past two and a half months, but has spent the last few weeks stabilizing at around $40 per share. The question at this stage, of course is whether the company’s fundamentals support the stock’s rise over the past nine months, and if so, what does that mean for its value proposition? Let’s find out.

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 $3.8 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined almost -42%, while revenue growth was flat, but negative at -0.17%. In the last quarter, earnings were -23.6% lower, while sales grew by 7.55%. The company’s margin profile had been showing impressive improvement through most of 2021, but has weakened throughout the past year. Net Income as a percentage of Revenues over the last twelve months was 3.91%, and weakened to 0.81% in the last quarter. I believe these declines are, at least in part, attributable to supply chain shortages and challenges that have persisted as a plague to multiple sectors and industries throughout the pandemic, and have been exacerbated by rising inflation, higher interest rates, and geopolitical concerns that began in 2022 and have persisted in 2023.

Free Cash Flow: FL’s free cash flow has deteriorated over the last year or so, from $714 billion to -$68 million six months ago, and -$65 million in the last quarter. This is a big red flag for me that, along with a reversal in the declining Net Income trend, would need to see improvement in the quarters ahead in order for the company to continue to service its debt, maintain its dividend, and invest in its business.

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 $446 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 were $551 million a year ago, and after dropping late in 2022, rebounded in the first quarter of this year to $536 million. The debt is still manageable, however the inflationary conditions I described above leave no room for error and are significant enough that they should give any investor pause.

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 in late 2022. That translates to a yield of 3.95% at the stock’s current price.

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 $25 per share. That suggests that the stock is overvalued by about -38% right now. It should also be noted that at the end of 2022, this same analysis yielded a fair value price at around $17 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 upward trend from its July 2022 low at around $24 to its February peak at around $47.50; it also serves as the baseline for the Fibonacci retracement lines on the right side of the chart. The stock has dropped off of that peak, finding its latest bottom at around $37 in mid-March and bouncing a bit higher from that point. The stock is now hovering in a range between current support at around $39 and immediate resistance at about $42. A push above $42 should give the stock room to rally to about $45 based on pivot high activity in that area in early March, with room to test the stock’s 52-week high at around $47.50 if buying activity increases. A drop below $37, on the other hand could see the stock drop to about $33 based on strong consolidation activity seen through October and November of last year along with a pivot low in December.

Near-term Keys: FL’s upward trend has clearly outpaced the stock’s value price, which along with a number of fundamental concerns are strong reasons FL really can’t be considered on any kind of strict valuation basis right now. If you prefer to focus on short-term trading strategies, the stock’s current price activity could offer some useful signals. Use a break above $42 as a signal to consider buying the stock or working with call options, using $45 as a practical profit target. if the stock drops below $37, you could consider shorting the stock or buying put options, with $33 offering an attractive profit target on a bearish trade.

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