The collapse of sneaker retailer Foot Locker, Inc. (NYSE:FL) has been one of Wall Street’s most interesting narratives in 2017. Once a near $80 stock earlier this year, FL stock dropped like a rock to under $30 in just a few months.
Source: Mike Mozart via Flickr
The catalyst? Nike Inc (NYSE:NKE) and other athletic brand companies pushing a direct selling strategy. There is a seismic shift in athletic retail right now from wholesale to direct (companies like Nike selling through their own channels, including their own stores). Foot Locker, being a wholesale partner of these brands, is simply caught on the losing side of this shift, alongside Dicks Sporting Goods Inc (NYSE:DKS), Hibbett Sports, Inc. (NASDAQ:HIBB) and Finish Line Inc (NASDAQ:FINL).
But the “death of FL stock” story is getting a makeover today after the company reported much better than expected quarterly numbers. FL stock is up more than 20% in early Friday morning trade.
Is this the beginning of a much prolonged rebound? I think so. While FL stock won’t bounce back to its 2017 highs of near $80, I do see another 40%-plus upside in this name to just under $60 over the next 12 months.
Here’s how I get there.
Things Aren’t That Bad at Foot Locker
Foot Locker’s quarter was a classic example of analysts and investors growing too sour on the name.
Everyone was trading FL stock as if it were near the end of its life on Wall Street. The price-to-earnings multiple had been chopped in half in 2017, falling from 15x earlier this year to 7x heading into the report. Earnings estimates had come down dramatically, with third-quarter estimates falling from $1.20 to 80 cents per share over the past 3 months. Comparable sales estimates for the quarter had fallen all the way to a decline of nearly 5% (they were up in the high single-digit range in March and April).
But things aren’t as bad as everyone fears at Foot Locker.
Earnings came in at 87 cents, still down year-over-year but much better than expected. Comparable sales fell 3.7%, which is still negative but far better than what was expected.
Moreover, Foot Locker is improving where it matters. Comps are still negative, but the 3.7% decline is far better than the 6% decline reported last quarter. Both quarters had the same lap (a 4.7% rise), so comparable sales trends are improving on both a 1- and 2-year basis. Moreover, the 2-year comparable sales stack is actually positive, implying positive comps may be around the corner for FL.
Gross margins are still falling, but the declines are moderating. That is equally as bullish as positive sales trends because it illustrates that FL margins may be bottoming out.
Plus, the big concern that Nike is pushing Foot Locker out and replacing them with Amazon.com, Inc. (NASDAQ:AMZN) seems overdone. FL revealed an elevated partnership model with Nike. The partnership includes rolling out innovative in-store and pop-up opportunities, including exclusive products.
That is huge. It means Nike still believes Foot Locker is a key distribution channel for their product, which in turn makes the rumors of Foot Locker’s death seem greatly overdone.
Why FL Stock Has More Upside
But none of this matters if FL stock has already rebounded back to a fair value.
FL won’t experience blistering top-line growth, but revenues look stable at these depressed levels. They should grow somewhere around 0%-2% per year over the next several years.
Meanwhile, the Nike partnership, which includes exclusive products, plus overall greater premium product availability in the marketplace implies that most of the margin erosion is in the rear-view mirror. Margins should be able to grow slightly over the next several years from this year’s depressed base.
Flattish revenue growth and some margin expansion plus big buybacks (FL has a bunch of cash it’s deploying to buybacks) should drive something like 5-10% earnings growth over the next several years. Call it 7.5%.
The S&P 500 is currently trading at 19.6x current year earnings for 10.4% earnings growth over the next several years. That is a 90% premium to growth.
Apply that 90% premium to FL stock. You get a “fair” price-to-earnings multiple of just over 14. A 14x multiple on what will likely be $4 earnings next year implies a 1-year forward price target of $56. That is another 40% upside over the next 12 months.
Bottom Line on FL Stock
When it comes to FL stock, reality is far better than what is priced into the stock.
That means this rebound is just beginning. I easily see another 40% upside over the next 12 months.
As of this writing, Luke Lango was long FL, DKS, NKE and AMZN.
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