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5 Reasons Foot Locker Stock Dropped to a 52-Week Low

Leo Sun, The Motley Fool

Foot Locker (NYSE: FL) is a battleground stock for the bulls and bears. The bulls argue that the stock is cheap and pays a high yield, and its positive comps growth and improving margins indicate that it's surviving the retail apocalypse.

The bears believe that the retailer will struggle against rising competition from direct-to-consumer (DTC) channels from top footwear makers like Nike (NYSE: NKE) and Adidas (OTC: ADDYY) and that sluggish mall traffic will exacerbate the pain.

A young woman shops for sneakers.

Image source: Getty Images.

Back in late May, I sided with the bulls and called Foot Locker an undervalued dividend stock. Since then, the stock tumbled more than 15% and currently hovers just above its 52-week low -- so my call was premature.

A big percentage of that decline occurred recently after Foot Locker's second-quarter numbers disappointed investors. Let's examine the five main issues that spooked the bulls and attracted the bears.

1. A top- and bottom-line miss

Foot Locker's total revenue declined 0.4% annually to $1.77 billion, which missed expectations by $60 million. Its adjusted net income fell 18% to $60 million, while its adjusted EPS slid 12% to $0.66, which missed estimates by a penny.

That marked the second straight quarter Foot Locker missed expectations on the top- and bottom-lines, which ended a four-quarter streak of earnings beats.

2. Decelerating comps growth

Foot Locker's top-line miss was attributed to its 0.8% comparable-store sales growth during the quarter, which marked its slowest growth rate in four quarters and missed the consensus forecast for 3.3% growth.

Period

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Comps growth

0.5%

2.9%

9.7%

4.6%

0.8%

Source: Foot Locker quarterly reports.

Foot Locker attributed that weak growth to soft sales in May, which offset its stronger sales in June and July, and declining comps at Kids Foot Locker, Footaction, and Eastbay, which offset the stronger growth of Foot Locker (across all its regions) and Champs.

On the bright side, Foot Locker expects a "mid-single-digit comp gain" for the third quarter, so it's still too early to claim that the retailer is struggling. Furthermore, Foot Locker consistently ranks as one of the top footwear retailers for teens in Piper Jaffray's semi-annual "Taking Stock with Teens" survey, so it's still more relevant to younger shoppers than other brick-and-mortar retailers.

3. Concerns about DTC competition

Foot Locker didn't mention the competition, but the growth of Nike and Adidas' DTC channels also likely throttled its growth. Nike's Direct revenue surged 16% annually (in constant currency terms) to $11.8 billion last quarter, buoyed by a 35% jump in its e-commerce sales and 6% comps growth at its stores.

Two women try on sneakers at a shoe store.

Image source: Getty Images.

Adidas' e-commerce revenue rose 37% annually last quarter as its North American sales grew 6% (in constant currency terms). Both Nike and Adidas are aggressively expanding their brick-and-mortar footprints to widen their moats against smaller challengers, which could hurt "middlemen" vendors like Foot Locker. However, Foot Locker is fighting back with its own DTC sales -- which is a double-edged sword, because it reduces its gross margins with higher freight costs.

4. Contracting margins

More DTC sales are the main reason Foot Locker's gross margin contracted sequentially and annually to 30.1% during the second quarter.

Period

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Gross margin

30.2%

31.6%

32.4%

33.2%

30.1%

Source: Foot Locker quarterly reports.

Those declines look dire, especially alongside its slowing comps growth, but Foot Locker claims that its gross margin will actually expand 10 to 30 basis points annually during the third quarter, which indicates that its DTC spending will gradually stabilize. Moreover, Foot Locker's gross margin declines aren't being caused by markdowns, which struggling retailers often use to boost their comps growth.

5. Concerns about tariffs

Lastly, the U.S.-China trade war is casting a cloud over Foot Locker's future, since the fourth tranche of tariffs on Chinese goods -- which go into effect on Sept. 1 -- will hit the apparel and footwear markets.

During the conference call, CFO Lauren Peters stated that Foot Locker was "actively discussing" tariffs with its vendor partners to "limit the impact" on its business, but noted that its current guidance didn't factor in the potential impact of those tariffs. That uncertainty should make investors skeptical about Foot Locker's rosy guidance for the third quarter.

So is Foot Locker still an undervalued dividend stock?

If investors take Foot Locker's guidance at face value, then it looks like an undervalued income stock with a forward P/E of seven and a forward yield of 4.5%. However, Foot Locker's previous guidance for a "mid to single-digit comp gain" in the second quarter was well below the 0.8% growth it actually reported, so investors should take its guidance with a grain of salt.

I don't think Foot Locker is in trouble yet, but I'd like to see if it hit its guidance targets next quarter and mitigates the incoming tariffs before I buy any shares.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Nike. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com