I’ve been a Foot Locker (NYSE:FL) bull for a long time. When FL stock plunged in 2017 on fears that the company was being squeezed out by e-commerce and direct-retail competition, I sounded the bull horn, calling such fears premature and overstated given Foot Locker’s strong, premium brand positioning among consumers. Since then, FL stock has rallied over 40%, while the S&P 500 has been flat during that same stretch.
More recently, I wrote that FL stock could rise further due to the renewed strength of Nike (NYSE:NKE). My thesis was simple. About 70% of Foot Locker’s merchandise is made by Nike, and NKE is on fire right now and is forecast to remain on fire for the foreseeable future.
Moreover, Foot Locker stock is dirt-cheap, and does not reflect expectations for the better-than-expected results it will probably report due to the Nike rebound. Consequently,Foot Locker stock has room to rise.
Two Upgrades of FL Stock
This bull thesis is starting to gain mainstream momentum. Over the past month, two major Wall Street firms (Jefferies and Baird) have upgraded Foot Locker stock based on the shares’ discounted valuation and the Nike catalyst. Not coincidentally, FL stock has rallied more than 20% over the past few weeks in the wake of these upgrades.
This rally has legs. Foot Locker’s fundamentals imply that Foot Locker stock can exceed $60 in the near future, and the retailer’s next earnings report could be the catalyst that gets the shares to that level.
All in all, FL stock looks good here and now. As the Nike-based bull thesis gains momentum over the next several weeks and months, FL stock should rally in a big way due to its discounted valuation.
All About Nike
When it comes to the near-term bull thesis on Foot Locker stock, it all comes back to Nike.
Nike is simply on fire right now. There’s no other way of putting it. Two weeks prior to Apple’s (NASDAQ:AAPL) warning about dramatically slowing growth in China, Nike said that its China business was not only growing at a 30%-plus rate, but that it was also growing at its fastest rate in several years. In other words, even as China’s economy slows, Nike’s numbers there are getting better.
That’s how hot Nike is right now. Its business is accelerating everywhere. Its sales growth in North America accelerated from 6% in Q1 to 9% in Q2. The sales growth of its Europe, Middle East, and Africa region surged from 9% to 14%, while its growth in the Asia-Pacific region inched up from 14% to 15%. In broad and simple terms, Nike is firing on all cylinders across all geographies.
That’s excellent news for Foot Locker. For all intents and purposes, Foot Locker is Nike’s footwear retailer. Roughly 70% of the company’s merchandise comes from Nike. Thus, as goes Nike, so goes Foot Locker.
Not surprisingly, then, as Nike has re-emerged as the hottest brand in the athletic-apparel space, Foot Locker’s results have meaningfully improved. Following a multi-quarter streak of negative comparable sales growth, Foot Locker has now recorded two consecutive quarters of positive comps, including a near- 3% comp last quarter. The company’s overall revenue growth has also stabilized, while its gross margins have gone from compressing over the past few years to expanding over the past two quarters.
This trend will persist. Nike’s most recent quarterly numbers ,reported in December , were very good. Since then, data research firms have reported that the 2018 holiday shopping season set records. As a result, it seems very likely that Foot Locker had a tremendous holiday quarter, supported by a red-hot Nike against the backdrop of a red-hot retail scene.
Foot Locker’s holiday earnings are due in roughly two months. Those earnings will be very good and will provide the necessary firepower to shoot Foot Locker stock above $60.
The Valuation of FL Stock Implies Healthy Upside
FL stock has room to rise on better-than-expected numbers because the valuation of Foot Locker stock is anemic and doesn’t price in any good news.
At its current levels, FL stock trades at just over 11 times its forward earnings. That’s a low multiple. It is below the stock market’s average forward multiple of 14. It is also well below the apparel retailers’ average forward multiple of 16 and the footwear sector’s average forward multiple of over 20. Most importantly, it is below Foot Locker’s five-year average forward multiple of 13. Thus, the multiple of FL stock can rise meaningfully.
In the big picture, Foot Locker is a leading retailer with staying power in an active-wear industry that is growing at a steady and stable mid-single-digit-percentage rate. Foot Locker may lose some share in that industry given its direct-retail competition. But its revenue growth should still stabilize at around 1%-2% per year over the next several years. Adding in gross-margin expansion and some cost leverage, its earnings per share should reach roughly $7 by fiscal 2023.
Placing FL’s historical average forward multiple of 13 on EPS of $7 equates to a fiscal 2022 price target of $91. After discounting back by 10% per year, we generate a fiscal 2018 price target of $62. FL stock should head towards that level after FL reports its holiday results.
The Bottom Line on FL Stock
The bull thesis on Foot Locker stock is starting to gain mainstream momentum. As it does, FL stock will continue to rise due to improved sentiment, better-than-expected earnings, and multiple expansion. This combination will drive the stock above $60 within the next few months and even higher thereafter.
As of this writing, Luke Lango was long FL, NKE, and AAPL.
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