2023-06-20 01:04:41 ET
Summary
- Foot Locker faces challenges from online retailers and suppliers like Nike building their own online shops, potentially impacting the company's long-term business model.
- The company is experiencing inventory issues and is working to increase its e-commerce presence and reduce its exposure to Nike.
- In the long term, their shift to more online shopping could be a challenge.
Thesis
Foot Locker ( FL ), probably the world's best-known shoe retailer, is in a difficult situation. Its bricks-and-mortar business is highly capital-intensive, and it faces increasing competition from online retailers. In addition, their suppliers, such as Nike ( NKE ), are building up their own online shops and selling more and more online, with better margins than when they sell through retailers such as Foot Locker.
So I think Foot Locker is in a difficult situation and I personally would not invest in this business for the long term because I think the business model of Foot Locker is going to face difficult times in the future.
Analysis
Foot Locker Investor Presentation
Foot Locker's most recent results were underwhelming as they missed estimates and also lowered guidance for the year. In its largest market, NA, revenue fell by 12.8% and this trend is likely to continue until the end of the year. Results in EMEA, however, were quite positive as Foot Locker Europe was able to grow its sales and results were only dragged down by the Sidestep exit , which will end by the middle of the year and where they are currently liquidating inventory.
In general, Foot Locker is experiencing some inventory issues at the moment due to the economic situation and therefore weaker demand, and they are also feeling the temporary problems of Nike. If you are interested in an analysis of Nike's prospects and why I think they are attractive in the long term, you can read it here .
Nike currently accounts for between 60% and 70% of Foot Locker's sales, so they are very sensitive to Nike's business. Nike's most sought after sneakers like the Nike Dunk Low Pandas, Jordan 3/4 or Air Force 1 collaborations have no demand problems, these sneakers still sell out in 15 minutes or less. But Nike sells most of these through their own SNKRS app and only small quantities through retailers like Foot Locker or others.
So Foot Locker has some of the Nike shoes that are not selling so well at the moment and are sitting on the shelves or need to be discounted to sell. Some of the Air Max versions that were in demand a few years ago are currently discounted by almost 50% on the Foot Locker website.
This will have an impact on future margins and, given the +25% year-on-year increase in inventory, Food Locker will have to make a significant reduction in its inventory levels.
Foot Locker Investor Presentation
And the management of Foot Locker also knows that the exclusive sneakers are what is driving the sneaker culture today, so their goal is to increase that in the long term and also to reduce their exposure to Nike, which I think is also the right thing to do. However, getting the exclusive shoes is not an easy task as this is a highly competitive industry and all the shoe retailers are trying to get their hands on them.
Foot Locker is also trying to increase its e-commerce to 25%, but why should the shoe manufacturer sell through Foot Locker's online store when they can sell through their own online store and make better margins by cutting out the middleman? Nike, for example, is aggressively investing and growing its online business. It has gone from 9% of its business to 27% in just 4 years.
One argument for Foot Locker is that people often like to try on shoes before they buy them, so the stores are important. But I know a lot of people who try on shoes in stores and then buy them online because you can usually get a better price, and I also know a lot of people who do all their shoe shopping online because the return policy and the whole process is easy and pleasant. I think the online presence of all footwear retailers and manufacturers will continue to grow, and shops in shopping centers or cities will probably be a declining industry.
In addition, Foot Locker is dependent on footwear manufacturers, who have pricing power for their hot styles, which makes the situation difficult. It was different 15 years ago, when Foot Locker could guarantee a nationwide release, but now all you need to do is put your shoes in your own online stores and you can easily reach most of the world.
Foot Locker ROIC
Foot Locker has historically been an efficient allocator of capital, generating double-digit returns well in excess of its WACC, making its low to mid-teens ROIC target achievable. And companies that grow ROIC are some of the best investments if bought early enough in their cycle, often resulting in strong returns for shareholders.
However, I think the business landscape has changed and the shift to more online will make it much harder to achieve the same ROIC in the future. COVID, in particular, gave a big boost to online businesses and many companies invested heavily during this period. But if Foot Locker can get back to a 15% ROIC while most likely having a 10% WACC and therefore a 5% spread, that would be a nice reward for shareholders.
Nevertheless, I believe that ROIC will be more in the lower end of the guidance range going forward, and therefore the spread between the cost of capital and the return on capital will be much lower.
Reverse DCF
As a basis for my reverse DCF analysis to see what is currently priced into the share price, I took the upper end of Foot Lockers Management's guided EPS range, which is between $2.00 and $2.25. This leads me to the conclusion that they need to grow EPS by 14% per annum over the next 10 years in order to generate a 10% return per annum.
As the diluted EPS CAGR over the last 10 years is -0.23% , this may be a difficult task to achieve in the current business and economic environment.
Conclusion
Foot Locker was my go-to store when I was younger and wanted to buy new shoes, but in recent years I have moved more and more to online shopping and now I buy almost everything apparel related online. And this is a trend for many people, as we can see with Nike's online sales and Foot Lockers' guidance to sell more online.
And that is the crux of the matter, because footwear manufacturers no longer need Foot Locker to reach their target audience. They can do it through their own online stores and make better margins. So I would argue that Foot Locker will have a tough time going forward, but turnaround plays like this, if successful, can be very rewarding for shareholders. But the online shopping industry is highly competitive. Companies like ASOS (ASOMF), which have a strong presence in Europe, are struggling despite having a high market share and brand awareness.
Foot Locker could be a short-term swing trade for me if the share price falls further and there is a catalyst, but I would not invest in it for the long term.
For further details see:
Foot Locker: Challenging Industry They Operate In