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Foot Locker Looks Like an Undervalued Dividend Stock

Leo Sun, The Motley Fool

Foot Locker's (NYSE: FL) stock recently plunged to a 52-week low after the retailer's first-quarter numbers missed expectations. Its revenue rose 3% annually (5% on a constant currency basis) to $2.08 billion but missed expectations by $30 million. Its adjusted earnings per share grew 6% to $1.53, but also missed estimates by $0.09.

But after that steep sell-off, Foot Locker trades at just eight times forward earnings while paying a forward dividend yield of 2.7%. That low multiple and solid yield make Foot Locker look like an undervalued dividend stock for a few simple reasons.

A young woman holding up two different sneakers while shopping in a shoe store.

Image source: Getty Images.

Solid comps growth

In the past, Foot Locker's comparable-store sales declined as footwear giants like Nike (NYSE: NKE) and Adidas (NASDAQOTH: ADDYY) opened their own brick-and-mortar and online stores. The bankruptcy of Sports Authority three years ago also flooded the market with excess inventory, while slowing mall traffic exacerbated the pain.

However, Foot Locker gradually reduced its store count, reduced its inventory levels, and focused on securing premium products from leading brands to attract younger shoppers. Those efforts lifted Foot Locker's comps back to positive territory over the past year:

Period Comps Growth
Q1 2018 (2.8%)
Q2 2018 0.5%
Q3 2018 2.9%
Q4 2018 9.7%
Q1 2019 4.6%

Data source: Foot Locker quarterly reports.

During the first quarter, Foot Locker's brick-and-mortar stores generated 2.9% comps growth as it offset a slight decline in store traffic with higher conversion rates. Its direct-to-consumer (DTC) comps improved 14.8%, thanks to the growth of its mobile app. Foot Locker also reaffirmed its full-year guidance for mid-single-digit comps growth.

Champs Sports, Foot Locker US, Foot Locker Canada, Foot Locker's overseas (Pacific and Europe) stores, Eastbay, Runners Point, and Sidestep stores all posted positive comps growth. Only two major banners -- Kids Foot Locker and Footaction -- reported single-digit declines.

Its total footwear comps rose by the mid-single-digits, while its apparel comps improved by the low single digits. The growth of those businesses offset a double-digit comps decline in accessories, which were throttled by soft sales of socks and hats.

Expanding margins and a strong teen presence

Foot Locker's gross margin also expanded sequentially and annually, as its robust comps growth offset the higher freight costs of its DTC business. The company expects that trend to continue with an improvement of 20 to 40 basis points to its gross margin for the full year.

Period Gross Margin
Q1 2018 32.9%
Q2 2018 30.2%
Q3 2018 31.6%
Q4 2018 32.4%
Q1 2019 33.2%

Data source: Foot Locker quarterly reports.

Foot Locker also seems to be locking in teen shoppers with premium products. Piper Jaffray's latest "Taking Stock with Teens" survey, which polled 8,000 U.S. teens regarding their favorite brands, ranked Foot Locker as teens' fifth favorite footwear "brand" after Nike, Vans, Adidas, and Converse.

Stable inventories and a reduced store count

Foot Locker's inventory rose just 0.1% annually to $1.21 billion during the quarter. During the conference call, CFO Lauren Peters stated that the company was rolling out RFID technologies at its stores in Europe to track and optimize its inventories. An expansion of that technology to other regions could help Foot Locker track shopper trends, quickly locate products, reduce theft, and improve the overall efficiency of its stores. 

A Foot Locker Power Store in Detroit.

Image source: Foot Locker.

Foot Locker also shuttered 34 stores (mostly in the U.S. and Europe) and reduced its global store count to 3,201 stores. However, the company is still opening stores in Asia, where it only operates six stores. It plans to open 15 new stores across Asia by the end of 2019.

Disciplined buybacks and stable EPS growth

Foot Locker authorized a new three-year $1.2 billion buyback plan in February, but it only repurchased $1.8 million in shares during the quarter. Peters stated that Foot Locker would buy more shares "when appropriate," but admitted that slower buybacks would reduce its prior full-year EPS guidance for double-digit growth to the "high single digits."

That news likely disappointed many investors, but it makes sense. Foot Locker likely expected its stock to tumble after its first-quarter report, so it would have been wasteful to repurchase shares before that decline. But with expectations now reset and the stock trading at its lowest valuation in about a year, it makes sense for Foot Locker to buy back more shares.

How Foot Locker could run faster

Foot Locker's forward P/E of 8 will probably rise slightly as analysts cut their forecasts. However, it still expects positive comps growth and high single-digit earnings growth this year, its gross margins are expanding, and its DTC business is growing in the face of tough competition from Nike and Adidas. Those factors indicate that Foot Locker is undervalued after its post-earnings plunge.

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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.