ADDDF - Foot Locker Could Exceed Expectations

Summary

• Foot Locker, Inc.'s stock had a good start to 2023 and nearly doubled from July's lows seven months ago.
• The management raised its full-year guidance to $4.42 EPS.
• Additionally, the company is continuously buying back around 3 million shares each quarter, which should boost EPS in the coming quarters.
• All in all, Foot Locker is on track to surprise Wall Street again, making its stock a value play and not a value trap.

1. Current business environment

According to Foot Locker, Inc. ( FL ) management and the third quarter results , the company is doing well in a difficult macroeconomic environment. One possible explanation is that shoes are very important products for all people regardless of age or country. FL can easily pass on higher costs to its customers who still pay high prices for well-known brands. Furthermore, young people are still hyped by sneakers promoted by famous athletes or entrepreneurs.

A possible headwind is the absence of major sports events in 2023, apart from the FIFA Women's World Cup in Australia and New Zealand. These events are normally increasing the sales of big brands like Adidas, Nike, Puma, or Under Armour. However, catch-up effects in leisure and sports after the pandemic are still a major factor and can drive sales of retailers like Foot Locker. All in all, 2023 can be a very promising year, both for the company and its shareholders.

2. Financials

As of November 18, FL reported revenues of $6.4bn (-3.1% YoY) for the first nine months of 2022. Earnings were sharply lower ($323 million vs. $790 million) due to a non-cash gain of $290 million in 2021 following an investment in GOAT. Hence, EPS have decreased but are not fully comparable. With 94.7 million shares outstanding, the management expects full year earnings to surpass $418 million ($4.42 EPS). If FL had a better than expected quarter and if the company bought back another 2-3 million shares, EPS could easily climb to $5. Expecting an EPS between $4.3 and $5.0 for the next two years seems to be realistic in case of a normalization of the macroeconomic environment.

Foot Locker has shown itself able to weather severe storms like the Corona pandemic, and the management has been able to create shareholder value under difficult conditions. The balance sheet is solid with an equity ratio of 42%, 53% higher current assets than current liabilities and manageable long-term liabilities.

3. Valuation

As of 02/05/2023 Foot Locker's market cap ($46.4) stood at $4.4 bn. With nearly $9bn in revenues, $418 million in earnings and $3.3bn shareholder equity, Foot Locker has very good ratios (based on 94.7 million shares):

(*average earnings of $520 million from 2015-2022)

Foot Locker also pays a dividend of $1.60 per share which results in a current yield of 3.45%. Further dividend increases because of the low payout ratio of 36% are likely. If the management continues its share buybacks, albeit at a lower pace due to the increased share price, the share count will decrease to 84 million at the end of 2023 and EPS will surpass $5.

Based on the company's financials, the positive business outlook and the high buyback potential, the shares are currently undervalued by nearly 30%, assuming a fair P/E ratio of 12 and EPS in 2023 of $5 (=$60).

4. Risks

A widely discussed risk for Foot Locker is that Nike or Adidas could cut off the "middle man" and further invest in their own online channels. However, the store chain is still very popular and both footwear and sporting goods producers are aware of this fact. FL is an additional option for them to distribute their well-known products and it is more likely that both want to strengthen these successful business relationships.

Another risk is an economic downturn combined with a decreased consumer spending for high-priced shoes. 2022 has shown that the inflationary environment did not hit the company's revenues and that after-pandemic catch-up effects increase consumers' willingness to invest more in their personal wellbeing and individual sports activities. Hence, the current environment is challenging on the one hand, but also favorable for Foot Locker on the other hand as long as the company manages to pass on higher costs to its customers.

5. Acquisitions

In the past, investors argued that Foot Locker, Inc. paid too much for its acquisitions . Although $1.1bn seem to be a high price for both chains, both shoe retailers do well and the number of stores is steadily growing (WSS +10 and atmos +2 in the first nine months of 2022) while FL's total store number decreased (-64) during the same period. So both acquisitions are likely to be positive for FL's business in the long term.

6. Conclusion

The upcoming full year report can strongly surprise Wall Street, and by announcing a new buyback program, a dividend increase and a positive business outlook for 2023, Foot Locker, Inc. has three options to boost Foot Locker's share price. However, the recent 25% gain since the start of the year already indicates the traders' bullish sentiment for the retailer. Nevertheless, the low valuation of the stock, the ongoing sneaker hype, and the value creation by the management lead to another 30% upside potential for the stock. All in all, Foot Locker, Inc. should be part of a value portfolio in 2023.

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