One of the most dramatic collapses in the retail sector has been with Foot Locker, Inc. (NYSE:FL). Seemingly over night, Foot Locker went from retail winner to retail loser as the athletic retail landscape shifted in favor of direct selling models. Foot Locker stock dropped from $80 in April 2017 to $30 by October 2017.
But that is only half of the story.
One of the most impressive rebound stories in the retail sector also belongs to Foot Locker. After bottoming in October 2017 around $30, FL reported a double-beat quarter which showed that the worst in terms of comparable sales declines and gross margin erosion was in the rear-view mirror. Then, analysts started turning bullish and investors started buying.
Since bottoming at $30 in October, Foot Locker stock has rebounded to $45 in just a few months.
Is there more firepower in this rebound story? I think so. Despite secular changes coming to the athletic retail world, Foot Locker remains an important and irreplaceable part of the product distribution model. As such, long-term sales growth and margins should be stable. Foot Locker stock isn’t priced for stable at current levels, and consequently, there is more upside left.
Here’s a deeper look:
Why Foot Locker Stock Dropped
Foot Locker dropped big time in 2017 because the company seemed to finally fall victim to adverse secular changes happening everywhere in retail. Namely, the company started to lose traffic to more direct selling channels like Amazon.com, Inc. (NASDAQ:AMZN).
To make matters worse, not only were consumers starting to opt for direct selling channels, but athletic retail brands like Nike Inc (NYSE:NKE) were also aggressively pushing their own direct selling channels.
Nike and others discovered that the best way to compete with Amazon is to have distinguished sales channels, and the best way to have distinguished sales channels is to put your product in channels that are aesthetically pleasing and relevant.
Unfortunately for many wholesaler retailers, their sales channels were neither aesthetically pleasing nor relevant. So they lost product from big athletic brands, and as a result, many of them closed shop.
When Foot Locker’s numbers went sour in early 2017 (comparable sales declines and margin erosion), investors immediately threw FL stock in the bin of athletic retail stocks that were getting squeezed out by secular changes in retail. Consequently, Foot Locker dropped from $80 to $30.
Why Foot Locker Stock Is Rebounding
Since then, Foot Locker has rebounded because investors have started to realize that not all wholesale distribution partners in the athletic retail world should be treated the same.
Foot Locker, unlike many of its peers, has a distinguishable, recognizable, and favorable brand image. This is partly due to the fact that the company has major endorsement deals with some high-level athletes, particularly NBA athletes.
It is also partly due to the fact that Foot Locker employees wearing referee jerseys has become somewhat iconic. And it is also partly due to the fact that Foot Locker is just so big and has a ton of reach.
For all those reasons, Foot Locker is actually a very important and irreplaceable part of the product distribution model for athletic retail brands.
If Nike, Under Armour Inc (NYSE:UAA), or Skechers USA Inc (NYSE:SKX) stopped shipping product to Foot Locker, that would be a lose-lose situation because FL reaches so many consumers and still has heavy foot and digital traffic.
Investors started to realize this once the numbers started getting better in the back-half of 2017. Foot Locker stock has concurrently rebounded.
Why There’s More Room To Rally
In the big picture, this is a long-term growth company that had a bad 2017 due to adverse changes in the athletic retail selling model. But those changes will shake out, and at the end, Foot Locker will still be an important part of the athletic retail landscape.
From 2013 to 2016, comparable sales growth was, on average, more than 6% per year. That is astounding. Granted, comparable sales were down 3% this past year, but growth is expected to come back into the picture this year.
Given the company’s strong track record and aforementioned secular changes, it isn’t unlikely that comparable sales growth does once again turn consistently positive.
Also from 2013 to 2016, gross margins were steady in the 33% to 34% range. They fell to 31.6% last year as adverse traffic conditions weighed on margin performance. But higher volume premium product is coming to market in mid-to-late 2018, and that premium product should bring gross margins back up.
Longer-term, gross margins should be able to normalize around historical levels.
If comparable sales growth does come back into and stay in positive territory, and margins normalize, then Foot Locker is looking at solid earnings growth over the next several years. Indeed, I think Foot Locker can net earnings per share of roughly $5.70 in 5 years, assuming 0-2% revenue growth, margin stabilization, a reduced tax rate, and continued buybacks.
Throwing a historically average 13-times forward multiple on those $5.50 earnings implies a four-year forward price target of $74. Discounted back by 10% per year, that equates to a present value of just over $50.
Bottom Line on FL Stock
The rebound in FL stock has begun. But it isn’t over. This stock has clear runway to $50 and up over the next several months.
As of this writing, Luke Lango was long FL, AMZN, and SKX.
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