ADDYY - Foot Locker: Time To Cash In After Post-Q3 Pop

2023-12-01 14:54:19 ET

Summary

• Foot Locker had a better-than-expected Q3, beating analyst estimates and experiencing a stock jump of nearly 18%.
• The company's entry into the Indian market is a positive move, but it faces competition and the need for partnerships with local brands.
• The partnership with the NBA offers growth opportunities for Foot Locker's loyalty program, but inventory concerns and overvaluation are still issues.

Investment Thesis

Foot Locker, Inc. ( FL ) had a better-than-expected quarter, as both the top line and bottom line beat analyst estimates. The company also came out with the positive news that it had a stellar Thanksgiving weekend, which resulted in its stock jumping nearly 18% in a single session.

In this article, I do a deep dive at FL's third quarter earnings report and argue that despite some promising developments, it's best to take your money off the table when it comes to this retailer.

A Snapshot of Q3 Performance

All things considered, Foot Locker, in my opinion, had a third quarter that was largely positive. While revenues of $1.99 billion were down 8.6% Y/Y , they beat analyst estimates by $30 million. Diluted EPS came in at $0.30, down approximately 70% Y/Y, yet beating analyst estimates by $0.08.

Management announced that the company witnessed strong sales during the Thanksgiving weekend , which enabled them to boost their FY23 revenue guidance, with sales now expected to be down between 8 and 8.5%, as opposed to being down between 8 and 9%. FY23 non-GAAP EPS, though, was narrowed further and is now expected to come in between $1.30 and $1.40, as opposed to between $1.30 and $1.50.

Entry into India a Good Move but Comes With Question Marks

One of the major announcements made during the FL's third quarter earnings call was that the company was entering the Indian markets in 2024 , via licensed partnerships. On the brick-and-mortar end, the company will be partnering with Metro Brands Limited. Nykaa Fashion, on the other hand, will be the company's partner for e-commerce.

The sneaker market in India has been steadily growing, and is expected to grow at a decent pace. According to Statista, the Sneakers segment is expected to generate $2.63 billion in revenue in 2023, and is then expected to grow, at a CAGR of 6.18%, to $3.55 billion in 2028. Therefore, FL's decision to enter the Indian markets is the right one, in my opinion, as the market could be a strong growth lever for the company in the coming years. Furthermore, Metro Brands and Nykaa Fashion are strong local retailers, with the former operating more than 700 stores across the country , and the latter a strong cosmetics-to-fashion e-commerce platform.

While there are positives to take from the company's decision to enter into one of the rapidly growing sneaker markets, several challenges await for FL. First, the competition is heating up in India. For instance, earlier this year , FL's future rival, Bata India , which has brands such as Hush Puppies and Scholl, was in partnership talks with Adidas that could result in the German shoemaker being a wholesale partner of Bata. This could spell bad news for FL if the deal comes to fruition.

Moreover, according to Statista, the Indian consumer is on the lookout for unique designs that blend traditional Indian elements with modern trends, which suggests that Foot Locker would have to first forge partnerships with local brands such as 7-10 and The Saree Sneakers , even before making their entry into the Indian market.

All things considered, the move into India should benefit FL in the long run, although this strategy is not without question marks.

NBA Deal Offers a New Avenue of Growth For Its Loyalty Program

The other major takeaway from FL's third quarter was the company's partnership with the NBA, through which, FL would become " an official league marketing partner in the US ." This is a great opportunity for FL, as it allows it to market to the NBA's 84 million followers on Instagram, thereby providing a new channel to acquire customers. The agreement will also allow FL to capitalize on key events such as the NBA All-Star Game to acquire customers and potentially grow revenues.

Furthermore, the deal with the NBA offers the company, an opportunity to grow its loyalty FLX program, which is one of the key pillars of the company's Lace Up strategy. The company, during the third quarter, saw the loyalty program account for 23% of the sales, a marginal uptick Y/Y. FL has set itself a target of 50% of sales coming from the loyalty program by 2026. By offering additional benefits through its loyalty program, as a result of the deal with the NBA, will allow the company to make significant progress towards achieving the target.

FL has had a 25-year relationship with the NBA. And its key partner Nike is one of the biggest brand partners of the league, which gave FL an indirect exposure. Through this new deal, the company stands to gain more direct exposure to the league, and it now has a new avenue for growth for its loyalty program.

Inventories Continue to be a Concern

Despite some positive moves made by the company, there were also issues that investors need to worry about. And the major issue right now, in my opinion, is the inventory situation. While the guidance for Q4 suggests that overall inventories for FY23 would be flat to down Y/Y, in the quarter gone by, inventories were still up 10.5% Y/Y albeit down slightly compared to Q2.

Furthermore, management, during the earnings call, also mentioned that they are likely to rely on promotions during the holiday season, to bring down inventories. This is a genuine concern, especially since FL's competitors have largely sorted their inventory issues out and are bringing new products on their shelves. Having to rely on outdated products, especially during the holiday season, could have an adverse impact on the company's top and bottom lines in the coming months.

Furthermore, as I mentioned earlier, the entry into Indian markets would most likely require FL to partner with local sneaker brands. I am not sure how the company would be able to sustain new partnerships while at the same time attempting to clear out its existing inventory.

Valuation

Sources: Refinitiv, FL's Q3 Earnings Report, and Author's Calculations

The company, as I mentioned earlier, now sees FY23 EPS coming in between $1.30 and $1.40. I have assumed the midpoint of the company's guidance for my calculations, which would be $1.35.

The company, according to Refinitiv, is currently trading at a forward P/E of 14.3x. Historically, the company's 10-year median P/E multiple has been 11x, which contributes to my view that the company is overvalued at current levels. However, given that there are some potential growth levers for FL, such as the deal with the NBA, I'm forecasting a slightly higher multiple of 12.2x, which is incidentally the 15-year historical median P/E multiple of FL.

According to Refinitiv, the company's earnings are not expected to grow in the next twelve months. However, under the assumption that the deal with NBA and the entry into Indian markets goes smoothly, I have assumed an FY24 EPS of $1.40, which is the higher end of the company's current guidance and implies a slightly optimistic 4% earnings growth.

A forward P/E of 12.2x and an FY24 EPS of $1.40 would result in a price target of $17, which implies a 37% downside from current levels.

Upside Risks

The main risk factor to my thesis would be that the deal with the NBA goes better than expected and that the future earnings come in much better than expected.

Furthermore, there is also the risk that the company has a bumper holiday season, which would allow it to clear its inventories faster, thereby enabling it to sell more full-price items than anticipated.

Concluding Thoughts

FL had a better-than-expected third quarter. And the stock had every right to jump nearly 18% post the results, especially since the company had a solid Thanksgiving weekend. The partnership with the NBA as well as the company's planned entry into India are all strong catalysts for the future.

However, at the moment, issues continue to plague the company. Inventories remain elevated and the company expects to continue to rely on promotional activity for the foreseeable future. Even its potential entry into India is fraught with risks, especially given that the Indian consumer prefers local sneaker brands, compared to FL's existing partners.

Finally, from a valuation standpoint, the stock does appear to be significantly overvalued. The post-earnings pop in the stock was certainly great. Now though, in my opinion, it's time for shareholders to cash in on this retailer whose struggles are far from over.

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