Athletic retail giant Foot Locker, Inc. (NYSE:FL) reported robust first quarter numbers on May 25 that topped expectations on both the top and bottom lines. Foot Locker stock is up nearly 15% to over $50 in response to those strong numbers.
This recent earnings pop continues what has been a multi-month rebound in Foot Locker stock from below $30 to above $50. Can this rally continue?
I think so. But I also think that shares are nearing fair value territory, and as such, I think that doing some profit-taking here and now isn’t all that bad of an idea.
The reality is that Foot Locker is still an important player in the athletic retail world. But the company isn’t as important as it used to be.
Above $50, the stock price is starting to reflect this “still important, but not as important” reality.
Here’s a deeper look:
What Happened to Foot Locker?
Up until early 2017, Foot Locker was considered a retail survivor because shoe enthusiasts still wanted to try on shoes in store before buying them. This gave the company a moat against digital retail encroachment.
But then the athletic retail landscape changed, and everything started going direct. Namely, big athletic brands like Nike Inc (NYSE:NKE) started aggressively pushing product through direct channels, such as their own stores. That created more competition for wholesale athletic retail partners like Foot Locker, and the net result was a shrinking of the wholesale athletic retail pie.
Indeed, this is a space where there have been a ton of bankruptcies over the past several years.
Foot Locker, naturally, was a victim of this shrinking. Last year, comparable sales fell into negative territory. Gross margins eroded. Foot Locker’s profitability went down the drain, and the stock dropped.
From $80 to $30.
Why Is Foot Locker Stock Rebounding?
But that dramatic selloff was overdone.
Investors were pricing Foot Locker stock as if the company were going to follow in the footsteps of Sports Authority and close shop.
But that won’t ever happen to Foot Locker. Unlike many other wholesale athletic retail partners, Foot Locker is an important and indispensable part of the athletic retail distribution model.
Foot Locker has a strong brand, thanks to high-profile partnerships with NBA athletes. They are big and reach a ton of customers. And they are somewhat iconic, as the employee jerseys have become a symbol in the athletic world.
Because of this, Nike and other big athletic brands need Foot Locker to maximize exposure to the end-consumer.
The numbers are starting to show this. Comparable sales growth, while still negative, is improving and expected to inflect into positive territory later this year. Meanwhile, gross margin erosion is moderating thanks to a bigger in-flow of premium product from big brands like Nike.
Now that numbers point to Foot Locker’s staying power in the athletic retail space, investors are buying up what was a dirt-cheap stock. The result? Foot Locker stock rallying around 70% over the past several months.
How Much Higher Can Foot Locker Stock Go?
I was a big bull on Foot Locker when it was at $30. In the $40’s, I remained bullish. But in the mid-$50’s, I have my reservations.
Foot Locker still is an important part of the athletic retail distribution model, but less important than it was two years ago. After all, Nike is still opening a ton of stores, building out its website, and overall pushing direct over wholesale.
Consequently, the days of mid single-digit comparable sales growth, big unit growth, and robust margin expansion are over for Foot Locker. Instead, this is a company with smaller growth prospects and minimal margin expansion potential.
From this perspective, I look at Foot Locker as a company with low single-digit comparable sales growth potential. Meanwhile, margins should rebound from today’s lows, but remain off 2014 highs because the operating backdrop is less favorable (lower sales volume and higher direct sales mix).
Under these assumptions, I think Foot Locker can net about $6.20 in earnings per share in five years. A historically-average 13-times forward multiple on $6.20 implies a four-year forward price target of just under $81. Discounted back by 10% per year, that equates to a present value in the mid-$50’s.
Granted, a 13-times forward multiple is below market-average, which is 16. A 16-times multiple on $6.20 implies a four-year forward price target of $99, and a present value in the upper $60’s.
Bottom Line on FL Stock
Can this rebound in Foot Locker stock continue? Yes. But in the mid-$50’s, Foot Locker is starting to look appropriately valued considering the company’s good, but not great, growth prospects.
As of this writing, Luke Lango was long FL.
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