Foot Locker is cheap but is it worth a buy?
Opdateret: 18. maj
Foot Locker is a brand that most of us know, and the stock is now trading close to their book value. It indicates that Foot Locker is now cheap but just because it is cheap, it doesn't necessarily mean that it is worth a buy. In this analysis I will share my thoughts on Foot Locker and decide if it is a buy or not 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 shares in Foot Locker. If you would like to know what I have in my portfolio, or you want to copy it, you can read how to do so here. I don't have much opinion about Foot Locker, I have bought some shoes in their stores but that is the only relationship I have with the company. As always, I will try to keep this analysis objective.
Foot Locker was founded in 1974 and is an American footwear and apparel retailer that operates 2.714 retail stores in 29 countries across North America, Europe, Asia, Australia, and New Zealand. In addition to these retail stores, they also have 142 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: Kids Foot Locker, Champs Sports, atmos, and WSS. Management believes that Foot Locker has a brand moat due Foot Locker having 12 million Instagram followers, which is 5x as many as their 4 top competing third-part retail banners combined. Furthermore, a third-party study showed that Foot Locker's brand health index is 20 % over the average of their peer set. Finally, their iconic brand positioning and strong customer base allows them to build scale with their vendors, which broaden their relationship with them. I tend to agree with management, and I believe that Foot Locker has built a brand moat, albeit a small one, through their many years in the business.
Their CEO is Mary Dillon. She joined Foot Locker as a CEO in September 2022. Prior to joining Foot Locker, she was the CEO and member of the Board of Directors at Ulta Beauty. She also has experience from companies such as McDonalds and PepsiCo. She also sits on the Board of Directors at KKK & Co, which is a global investment company. She has a bachelor's degree in Marketing and Asian Studies from the University of Illinois. To pay her tuition for the university, she worked various jobs such as a waitress and housecleaner, which shows her hardworking attitude. in 2019 Marry Dillon was named one of Barron's best CEOs. While at Ulta Beauty, Mary Dillon managed to triple their market capitalization and doubling their revenue in 8 years, she is also credited with doubling the number of stores and loyalty members. I know Mary Dillon very well, as I used to own shares in Ulta Beauty, and the reason I sold the shares were that Mary Dillon stepped down as a CEO. Thus, I keep her in very high regards. I'm not the only one though, as the shares of Foot Locker surged 20 % when she was announced as a new CEO. Because of the little time she has been the CEO of Foot Locker, we cannot judge her based on her time there. However, I'm very confident in her as a CEO, and I feel confident in her being the right person to move Foot Locker forward.
I believe that Foot Locker has brand moat. I feel very confident in the management as well. Now let us investigate the numbers to see if Foot Locker does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will look into is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all years. I'm quite impressed with the numbers until 2019, where Foot Locker consistently delivered a ROIC above 10 %, and in some cases above 20 %. However, since 2019 Foot Locker has only managed to deliver a ROIC above the required 10 % once. Of course, Foot Locker has faced challenges such as a pandemic and macroeconomic challenging fiscal 2023. Nonetheless, I would like to see Foot Locker improving their ROIC moving forward.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. The equity growth has been quite consistent over the years since 2014. There was a peak in 2017 and it since dropped to the levels we saw before that. In fiscal 2022 Foot Locker has reached the highest book value + dividend ever and increased it in fiscal 2023. Thus, these numbers look good and hopefully Foot Locker will manage to grow their equity moving forward.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Foot Locker has managed to be free cash flow positive in 9 out of 10 years. Unfortunately, it is the last year that Foot Locker was free cash flow negative, which isn't nice to see if you are considering investing in Foot Locker. Up until fiscal 2023 Foot Locker delivered an acceptable free cash flow and levered free cash flow margin. It did decrease slightly in fiscal 2022, which was when Foot Locker acquired atmos and WSS. I don't want to dismiss Foot Locker as an investment based on the fiscal 2023 numbers alone, but I would like to see Foot Locker getting back to a positive free cash flow in fiscal 2024.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. Doing the calculations on Foot Locker, it shows a debt that can be paid off in 1,3 years. Hence, Foot Locker has an acceptable debt, and it isn't something that I would worry about if I was invested in Foot Locker.
Like with all other companies, there are some risks you need to consider, if you are going to invest in Foot Locker. The most obvious risk is that Nike will focus on direct-to-consumer sales. Approximately, 65 % of all merchandise purchased by Foot Locker in 2022 was from Nike. Hence, Foot Locker has been very dependent on Nike, and while management says that "we will continue to be strong, strategic partner of Nike's, and we are working on building complementary strategies to the direct to consumers growth", it is something that will hurt Foot Locker, especially in the short term. Another risk is competition. In their annual report, Foot Locker describes the retail athletic footwear and apparel business to be highly competitive. Foot Locker mentions that they not only compete with other traditional retailers, but they also compete with online retailers and their merchandise vendor suppliers direct-to-consumer channels. I believe that Foot Locker has a strong brand that protects them against traditional retailers. However, they mention in their annual report that fast shift in customer buying patterns to online could have a material adverse effect on their business results. Furthermore, their merchandise vendor suppliers are likely to focus on direct-to-consumer sales, as these have higher margins. We already saw it with Nike, and as a shareholder in Crocs, I know they are focusing on it too. Macroeconomics. The performance of Foot Locker is subject to global economic conditions. If there are tighter credit, negative financials news or declines in income, customers will spend less of their money in Foot Locker. The same goes with increased fuel and energy costs, higher interest rates and lower home values. All things we could possibly see in the foreseeable future.
It isn't all risks, there are also a lot of potential for Foot Locker moving forward. Foot Locker is cheap. Their book value per share is $35,29, which is slightly under the current share price (it might have changed when you read it). Their board has approved a quarterly dividend of $0,4 per share, which currently is around a 4 % yield. Foot Locker is also doing buybacks that management believes will lift EPS by low single digits. Recent acquisitions will grow their business. Foot Locker recently bought WSS and atmos. And while WSS contributed with $604 million and atmos with $188 million in sales in 2022, they expect to grow the businesses significantly. Management expects WSS to reach $1,3 billion in revenue by 2026, which would mean a CAGR of more than 20 %. Management expects atmos to reach $250 million in revenue by 2026, which would mean a CAGR of just below 10 %. Expanding the sneaker culture. At their latest investor day, management talked about expanding the sneaker culture by serving more sneaker occasions, providing more sneaker choice, and driving greater sneaker distinction. Right now, the sneaker penetration in the total footwear market is 43 % and management expects that to grow to 47 % in 2026, as it is getting more acceptable to use sneakers on different occasions. Focusing on apparel. Foot Locker has introduced their own private labels in LCKR their menswear line and Cozi their womenswear line. As these are private labels, they will have higher margins than brands from their merchandise vendor suppliers. As it is now apparel and accessory sales are 20 % of Foot Locker's sales as apparel was up low single digits in 2022, so there are plenty of room to grow. Growing their reward program. They have now rolled out their FLX reward program in Europe as well and will continue to roll out the program in other countries. On an annual basis they had a 50 % growth in active members. Their reward program allows Foot Locker to capture consumer data to better meet their customer's needs. It also incentivizes their customers to be engaged with their brand, while members of the reward program spend over 10 % more than their non-members. Management has mentioned that they want to maximize their program to attract a broader range of customers and better understand and serve them by leveraging their customer data.
All right, we have gone through the numbers, potential and risks regarding Foot Locker, and now it is time for us to calculate a price for Foot Locker. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 3,58 (which is the one from fiscal 2023). I chose an Estimated future EPS growth rate of 13 (which is the estimated growth by Finbox), Estimated future PE 26 (which the double of the growth rate, as the historically PE for Foot Locker has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $78,10, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Foot Locker at price of $39,05 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financials, keep in mind that all numbers are in millions. The operating Cash Flow last year was 173. The Capital Expenditures was 285. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 199,5 in our further calculations. The Tax Provision was 180. We have 93,395 outstanding shares. Hence, the calculation will be like this: (173 - 199,5 + 180) /93,395 x 10 = 16,44 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". However, Foot Locker had a negative free cash flow in fiscal 2023. Thus, I will not be able to make the PAYBACK TIME calculation.
Foot Locker is cheap at these levels. Personally, I would like to see a larger moat when I invest in a company. Nevertheless, there are some risks and potential you need consider when investing in Foot Locker. No doubt that the fact that Nike will focus on their own direct to consumer sales will hurt Foot Locker, as they are very dependent on Nike. We will probably see other companies focusing on direct-to-consumer sales as well. It is something that Foot Locker will need to navigate through, and I don't think you could have a better management to do so. I like that Foot Locker will focus on what they are best at and that is selling sneakers. However, I also believe that their acquisitions of atmos and WSS will be good for the company long-term. I believe that focusing on their loyalty program is also a good idea, as they will be able to leverage that data. Nonetheless, I would like to see Foot Locker getting back to a positive free cash flow and delivering a higher ROIC, before I will consider it as an investment. However, if you want to invest in Foot Locker, I believe that buying Foot Locker below the book value per share at $35,29 would be a solid entry point.
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