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Foot Locker: Is this cheap stock worth buying?

Opdateret: 14. jun.


Foot Locker is a well-known brand, and its stock is currently trading below its book value. It indicates that Foot Locker is now inexpensive, but just because it is cheap, it doesn't necessarily mean that it is worth buying. In this analysis, I will share my thoughts on Foot Locker and determine whether it is a good investment for me.


This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.


For full disclosure, I should mention that at the time of writing this analysis, I do not own any shares in Foot Locker. If you would like to know what is in my portfolio or if you want to make a copy of it, you can find instructions on how to do so here. I don't have a strong opinion about Foot Locker. I have only purchased some shoes from their stores, so that is the extent of my relationship with the company. As always, I will strive to maintain objectivity in this analysis. If you want to purchase shares or fractional shares of Foot Locker, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.



Foot Locker was founded in 1974 and is an American footwear and apparel retailer that operates 2.523 retail stores in 26 countries across North America, Europe, Asia, Australia, and New Zealand. In addition to these retail stores, they also have 202 franchised Foot Locker stores located in the Middle East and Asia. They also operate websites and mobile apps. Besides the well-known Foot Locker shops, they also own other brands such as Kids Foot Locker, Champs Sports, atmos, and WSS. Management believes that Foot Locker has a strong brand moat due to its 12 million Instagram followers, which is five times greater than the total number of followers of their top four competing third-party retail banners. Furthermore, a third-party study showed that Foot Locker's brand health index is 20% higher than the average of their peer group. Finally, their iconic brand positioning and strong customer base enable them to establish scale with their vendors, thereby expanding their relationship with them. I tend to agree with management, and I believe that Foot Locker has established a modest brand advantage, known as a brand moat, through their many years in the business.

The CEO is Mary Dillon. She joined Foot Locker as CEO in September 2022. Prior to joining Foot Locker, she served as the CEO and a member of the Board of Directors at Ulta Beauty. She also has experience from companies such as McDonald's and PepsiCo. She also sits on the Board of Directors at KKK & Co, a global investment company. She holds a bachelor's degree in Marketing and Asian Studies from the University of Illinois. To pay for her university tuition, she worked various jobs, such as being a waitress and a housecleaner, which demonstrates her diligent work ethic. In 2019, Mary Dillon was named one of Barron's best CEOs. During her time at Ulta Beauty, Mary Dillon successfully tripled the company's market capitalization and doubled its revenue in just 8 years. She is also credited with doubling the number of stores and loyalty members. I know Mary Dillon very well because I used to own shares in Ulta Beauty. The reason I sold the shares was that Mary Dillon stepped down as CEO. Thus, I hold her in very high regard. The shares of Foot Locker surged 20% when she was announced as the new CEO, indicating that I am not the only one who recognized her potential. Because she has only been the CEO of Foot Locker for a short period of time, we cannot make a fair judgment about her performance at the company. However, I have great confidence in her as a CEO, and I believe she is the right person to lead Foot Locker into the future.


I believe that Foot Locker has a brand moat. I also have a lot of confidence in the management. Now, let us investigate the numbers to determine if Foot Locker does indeed meet our requirements for a strong moat. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.


The first number we will look into is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all numbers exceeding 10% in each year. I am quite impressed with the numbers up to fiscal year 2022, where Foot Locker consistently delivered a Return on Invested Capital (ROIC) above 10%, and in some cases, above 20%. Since fiscal year 2023, Foot Locker has not managed to achieve a Return on Invested Capital (ROIC) above 10%. The Return on Invested Capital (ROIC) was slightly below 10% in fiscal 2023, but it turned negative in fiscal 2024. Foot Locker has faced challenging macroeconomic conditions, but delivering a negative Return on Invested Capital (ROIC) is never a good sign. Hopefully, fiscal 2024 will be an outlier, and Foot Locker will deliver a positive Return on Invested Capital (ROIC) in fiscal 2025. However, I do find the negative ROIC concerning and will be monitoring Foot Locker's progress through fiscal 2025.



The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Foot Locker has managed to grow its equity in most years and has only had three years of decline within the past decade, which is encouraging. However, its most significant decrease in equity occurred in fiscal year 2024, which is slightly concerning. The significant rise in equity in fiscal year 2022 was primarily attributed to the acquisition of WSS and atmos.



Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Foot Locker has managed to maintain positive free cash flow in 8 out of 10 years. Unfortunately, Foot Locker has delivered negative free cash flow in the last two years, which is very concerning. The levered free cash flow margin had been relatively stable leading up to the pandemic. The buying frenzy fueled by stimulus following the pandemic led Foot Locker to achieve its highest levered free cash flow margin in fiscal year 2021. However, the levered free cash flow margin significantly decreased in fiscal year 2022, remaining negative for the past two years, which is not an encouraging sign. The free cash flow yield has been negative for the past two years, which means it does not provide an indication of whether the shares are trading at a good valuation. However, we will revisit the valuation of Foot Locker later in the analysis.



Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. We calculate this by dividing the total long-term debt by earnings. It isn't possible to calculate using the numbers from fiscal year 2024 for Foot Locker because the company reported negative earnings. However, if we use the non-GAAP numbers, Foot Locker's debt-to-earnings ratio is 2,9 years. If we use the numbers from fiscal 2023, Foot Locker's debt-to-earnings ratio is 1,3 years. Therefore, the debt is at an acceptable level and should not be a concern when investing in Foot Locker.



When investing in Foot Locker, like with all other companies, there are some risks that you need to consider. One risk is competition. The retail athletic footwear and apparel business is highly competitive. Foot Locker primarily competes with athletic footwear specialty stores, sporting goods stores, department stores, traditional shoe stores, mass merchandisers, and online retailers. Additionally, it competes with its merchandise vendor suppliers' direct-to-customer channels. Foot Locker's major suppliers all operate retail stores and distribute products directly through their online stores. One example of a merchandise vendor that has prioritized direct-to-consumer sales is Nike, which is by far Foot Locker's largest supplier, as approximately 65% of all Foot Locker's supplies come from Nike. As Nike prioritized direct-to-consumer sales, other suppliers have not been able to fill the void, resulting in Foot Locker's revenue decreasing each year for the past two years. Foot Locker expects to expand its collaboration with Nike for the first time in two years in fiscal 2025. However, this highlights that Foot Locker not only competes with its traditional rivals but also with its suppliers who are increasingly focusing on direct-to-consumer sales, posing an ongoing risk. Failing to manage inventory levels. Foot Locker must maintain sufficient inventory levels to operate its business successfully. However, they must also guard against accumulating excess inventory. Foot Locker orders most of its footwear four to six months before delivery. If Foot Locker fails to accurately anticipate either the market for the merchandise or its customers' purchasing habits, the company may be forced to rely on markdowns or promotional sales to dispose of excess or slow-moving inventory. This could negatively impact its gross margins and have a significant adverse effect on its business. And that is exactly what had happened in the past couple of years. Foot Locker overestimated the longevity of the spending spree following the pandemic stimulus. Thus, Foot Locker is selling excess inventory at a discount, which means that customers are now accustomed to buying products at Foot Locker at a discount. Management has mentioned that it will take some time to transition consumer expectations away from the higher promotional levels. Macroeconomics. Foot Locker's performance is subject to global economic conditions and their impact on consumer spending levels. As a retailer dependent on consumer discretionary spending, Foot Locker's operational results are sensitive to changes in macroeconomic conditions. Continued uncertainty about global economic conditions poses a risk as consumers and businesses may postpone spending in response to macroeconomic challenges, which could have a material negative effect on demand for Foot Locker's products. Management has mentioned that the macroenvironment continued to weigh on the WSS consumer, particularly affecting its WSS brand. As a result, management has decided to temporarily reduce capital for new WSS store openings, which may affect the future growth of Foot Locker, as WSS serves the fastest-growing consumer segment in the U.S.


It isn't all bad; there are also reasons to invest in Foot Locker. One reason is that Foot Locker wants to expand the sneaker culture. At their latest investor day, management discussed their plans to expand the sneaker culture by catering to a wider range of sneaker occasions, offering a greater variety of sneaker choices, and promoting more distinct sneaker styles. Right now, the market penetration of sneakers in the total footwear market is 40%, and management expects it to grow to 47% by 2026. This is because sneakers are becoming more widely accepted for use on various occasions. Management believes that expanding the sneaker culture will be beneficial for Foot Locker in the long run. They aim to establish Foot Locker as the premier destination for discovering and purchasing all things related to sneakers worldwide. One way to achieve this is through their new global platform called "The Heart of Sneakers," which emphasizes that sneakers are more than just footwear. The launch of the Heart of Sneakers has been a success, with increased views and engagement on Foot Locker's social media channels exceeding expectations. Increasing digital sales. Foot Locker has started to enhance its channel mix and improve its customers' digital journey by making additional improvements in the customer experience. These enhancements include improved search and discovery capabilities, enhanced product listing and detail pages, better storytelling, and ongoing optimization of the shopping cart. As a result, Foot Locker's digital channel penetration now stands at nearly 20% at the end of fiscal 2024, which is an increase of 180 basis points from fiscal 2023. Foot Locker plans to launch a new mobile app in fiscal 2025. The app aims to enhance the shopping experience, improve connectivity with stores, and seamlessly integrate loyalty programs. The progress made so far in Foot Locker's digital transformation indicates that they are on schedule to achieve approximately 25% e-commerce penetration by 2026. Digital sales offer convenience, allowing customers to shop anytime and from anywhere, and this accessibility may lead to increased sales and customer satisfaction. Furthermore, digital sales usually have higher margins than in-store sales. The loyalty program. Foot Locker already has a loyalty program that enables the company to collect consumer data to better cater to their customers' needs. It also incentivizes their customers to engage with their brand, as members of the reward program spend over 10% more than non-members. However, management has mentioned that they want to maximize their program to attract a broader range of customers, better understand them, and serve them by leveraging their customer data. Thus, Foot Locker has launched its new FLX loyalty pilot program in Canada to a positive response. The pilot launch in Canada has resulted in higher engagement with first-time redeemers, a higher average order value, more units per transaction, and increased trip frequency. Foot Locker plans to roll out the FLX cash program across North America in 2024 and globally in 2025. Foot Locker aims to achieve a 50% loyalty penetration by 2026, which is expected to result in increased and more frequent sales.



Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.


The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. Foot Locker reported a negative EPS in fiscal 2024. Thus, I have decided to use its non-GAAP EPS of 1,42. I have selected a projected future EPS growth rate of 8%. Management expects non-GAAP EPS to grow by approximately 15% in fiscal 2025, but I don't think it is sustainable. Additionally, I have selected a projected future P/E ratio of 16, which is twice the growth rate. This decision is based on Foot Locker's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $12,12. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Foot Locker at a price of $6,06 (or lower, obviously) if we use the Margin of Safety price. If I have calculated the EPS from fiscal 2023, which was 3,62, the Margin of Safety price would be 15,45.


The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%. Foot Locker's operating cash flow was lower than its capital expenditures. Hence, it is not possible to make calculations based on the fiscal 2024 number. If you calculate based on fiscal year 2023, the figures would be as follows: The operating cash flow last year was 173, and capital expenditures were 285. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 199,5 in our calculations. The tax provision was 180. We have 94,162 outstanding shares. Hence, the calculation will be as follows: (173 – 199,5 + 180) / 94,162 x 10 = $16,30 in Ten Cap price.


The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. However, as Foot Locker has delivered a negative free cash flow in the past two years, I cannot make this calculation.


Foot Locker has experienced some difficult years, but I hold the management in high regard, and I believe the CEO may be the right person to turn the business around. Foot Locker has reported a negative Return on Invested Capital (ROIC) in fiscal year 2024 and negative free cash flow for the past two years, which is concerning to me. Foot Locker will always face competition from both its traditional competitors and its suppliers, who may want to prioritize expanding their high-margin direct-to-consumer sales, as seen with Nike. Managing inventory was a challenge for the previous management, leading to customers expecting promotional prices at Foot Locker. This situation makes it difficult for Foot Locker to increase prices. The new management has taken initiatives to improve inventory management in the future, and hopefully, Foot Locker will successfully raise prices. Macroeconomic factors are also affecting Foot Locker as they needed to slow down the store expansion of WSS, which serves the fastest-growing consumer segment in the U.S. Hopefully, the slowdown in store expansion won't have a long-term impact on Foot Locker. Foot Locker is working on expanding the sneaker culture, which will benefit the company in the long term. Foot Locker seems to be off to a good start with The Heart of Sneakers platform, and the market penetration of sneakers is also expected to grow. Foot Locker is expanding its digital sales, which could result in increased sales, improved customer satisfaction, and higher profit margins. The new loyalty program has also had a successful start, showing increased engagement, higher average order value, more units per transaction, and increased trip frequency. Thus, it could serve as a growth catalyst for Foot Locker when they roll out the new loyalty program in the United States in 2024 and globally in 2025. Nonetheless, all things considered, I believe the risks outweigh the rewards, and I will not be investing in Foot Locker at this time.


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4 Comments


Glenn
Jun 24, 2022

I apologize the late response. I haven't investigated it myself, as I don't plan on buying Foot Locker now. However, I found an article where the author commented on it in the comments:


"I dont think i would consider that really as debt, since they are more than offset with other assets they hold in their balance sheet. The reason is they use this leased space to make the money they are making, so although due to accounting changes in the rules we have to consider them as debt, it really is just an expense in the income statement according to me."


Link to the article: Foot Locker Is A Bargain At These Prices (NYSE:FL) | Seeking Alpha

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Ajay Arora
Ajay Arora
Jun 20, 2022

Hi Glenn. $FL is now below book value. (0,86). I have a question on your debt input. The long term debt end of Q1/22 is 451m but the long term capital lease seems huge at 2,3B. That seems lie a huge commitment comparing that to their latest quarter net income of 133m? I must be missing something.

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Glenn
Apr 25, 2022

Thank you so much for your kind words Ajay. I really appreciate it. I always value your comments and insights.

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Ajay Arora
Ajay Arora
Apr 24, 2022

Dear Glenn, a brilliant analysis. Thank you so much. I would def keep this under watch. I absolutely appreciate your balanced approach towards various metrics.

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