Foot Locker is cheap but is it worth a buy?
Opdateret: 26. dec. 2022
Foot Locker's stock has lost more than half of its value since May 2021 and Foot Locker is now trading below 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 2.858 retail stores in 28 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, Eastbay, atmos, WSS, Footaction and Sidestep. 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 Richard A. Johnson. He joined Foot Locker in 1993 and held many different positions until he became the CEO in 2014. The most well-known company that he has experience from before joining Foot Locker is General Motors. He holds a Bachelor of Arts from University of Wisconsin - Eau Claire. Besides his role in Foot Locker, he also serves on the boards of H&R Block, the Retail Industry Leaders Association (RILA) and the Footwear Distribution & Retailers of America. Under his leadership the strategy for Foot Locker is to be seen as a center of youth culture, which would differentiate them from other sneaker shops, and strengthen their brand moat. According to comparably, his employee ratings give him a score in the top 25 % of similar sized companies, which indicates that he is well-liked by his employees. In 2022 he got voted to serve as chair in RILA, which indicates that he is well-respected in the sector. His credentials within the sector, not only from Foot Locker, but also from the different boards. combined with him wanting to strengthen the moat of Foot Locker means that I feel rather confident in the management.
I believe that Foot Locker has brand moat. I'm 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 as they are consistently above 10 % except for the two years during the pandemic. I certainly didn't expect Foot Locker to have delivered such numbers, and I'm quite encouraged by the numbers.
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 2022 Foot Locker has reached the highest book value + dividend ever. While it is nice to see, I doubt that it will be sustainable over the long-term. Nevertheless, I believe the numbers are fine, but I would have liked to have seen some growth.
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. Foot Locker has delivered a positive free cash flow every year the last 10 years. The numbers have been more or less consistent from 2015 to 2020. It peaked in 2021 and dropped significantly in 2022. I'm not worried at all about the 2022 numbers, as Foot Locker acquiring WSS and atmos in their fiscal 2022 certainly had an impact on the free cash flow. I'm really encouraged by these numbers, and once again, I'm positively surprised by Foot Locker.
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 0,51 years. Hence, Foot Locker has very little debt, which is always nice to see.
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, 68 % of all merchandise purchased by Foot Locker in 2021 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. Supply Chain shortages, freight prices and higher wages. These are three different short-term risks, but I have combed them together, as they are all something that will affect Foot Locker, and in their latest earnings call, they mentioned that it will hurt margins and that they expect their margins to decline by 360 to 380 basis points in 2022. 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. And while management stated that they have not seen any material change in consumer behavior in the first quarter of fiscal 2023, they also stated that they are very conscious of the inflation increases.
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 $34,85, which is above 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 5 % yield. They are also doing a $1,2 billion share buyback. Recent acquisitions will grow their business. Foot Locker recently bought WSS and atmos. And while WSS contributed with $139 million and atmos with $49 million in sales in the fourth quarter in 2021, they expect to grow the businesses significantly. They expect WSS to reach $1 billion in sales by 2024 and grow atmos by 50 % to $300 million over the next 3 years. According to management both WSS and atmos perform ahead of the forecast so far. Focusing on apparel. They are growing their apparel business, and it grew by 30 % in the fourth quarter in 2021 and reached $1,4 billion in sales for the first time ever. They have introduced their own private labels in LCKR their new menswear line and Cozi their new womenswear line. 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.
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 4,25 (which is the lower end of their guidance of 4,25 - 4,60). I chose an Estimated future EPS growth rate of 7 (which is lower than what analysts expect but one I feel comfortable with), Estimated future PE 14 (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 $28,93, 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 $14,47 (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 136. The Capital Expenditures was 290. 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 203 in our further calculations. The Tax Provision was 199. We have 93,32 outstanding shares. Hence, the calculation will be like this: (136 - 203 + 199) /93,32 x 10 = 14,10 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". The free cash flow per share last year was 3,93 but I don't believe that to be sustainable. Hence, I have decided to cut it to 2,8 With the Free Cash Flow Per Share at 2,8 and a growth rate of 7 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $30,74.
Foot Locker is cheap at these levels. Personally, I would 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 have been very dependent on Nike previously. The question is if they diversify enough from Nike and grow other business to make up for the loss. There are other things not mentioned in this analysis such as them enhancing their omni-channel and making cost saving programs that should save them $200 million annualized. Their business will be challenged in the short-term due to what is mentioned in this analysis but if you believe that the management will execute on their new strategies and is happy in receiving a dividend yield of 5% while waiting, it could be an interesting investment. I don't want focus too much on the calculated prices. Instead, I would focus on book value. I believe that Foot Locker could be an interesting investment if the share trades below their book value per share of $34,85.
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