Company Overview: Foot Locker, Inc. is a retailer of shoes and apparel. The Company operates through two segments: Athletic Stores and Direct-to-Customers. The Company is an athletic footwear and apparel retailer, which include businesses, such as include Foot Locker, Kids Foot Locker, Lady Foot Locker, Champs Sports, Footaction, Runners Point, Sidestep and SIX:02. The Direct-to-Customers segment is multi-branded and sells directly to customers through Internet and mobile sites and catalogs. The Direct-to-Customers segment operates the Websites for eastbay.com, final-score.com, eastbayteamsales.com and sp24.com. Additionally, this segment includes the Websites, both desktop and mobile, aligned with the brand names of its store banners (footlocker.com, ladyfootlocker.com, six02.com kidsfootlocker.com, champssports.com, footaction.com, footlocker.ca, footlocker.eu, runnerspoint.com and sidestep-shoes.com).
 

FL Details

A Renowned Footwear Retailer: Foot Locker, Inc. (NYSE: FL) is one of the largest athletic footwear and apparel retailers in the world. With its subsidiaries, the company operates 3,221 stores in 27 countries. The company operates through its own stores, websites and mobile applications, aligned with the brand names of store banners (including footlocker.com, ladyfootlocker.com, six02.com, kidsfootlocker.com, champssports.com, footaction.com, footlocker.ca, footlocker.eu, footlocker.com.au, runnerspoint.com, sidestep-shoes.com, footlocker.hk, footlocker.sg, and footlocker.my). Geographically, the company has footprints across North America, Europe, Asia, Australia, and New Zealand.

The Company operates through two segments, North America and International. North America operating segment includes banners operating in the U.S. and Canada: Foot Locker, Kids Foot Locker, Lady Foot Locker, Champs Sports, Footaction, and SIX:02, including each of their related e-commerce businesses, as well as its Eastbay business that includes internet, catalog, and team sales. The International operating segment includes the following banners operating in Europe, Asia, Australia, and New Zealand: Foot Locker, Runners Point, Sidestep, and Kids Foot Locker, including each of their related e-commerce businesses. The top five suppliers account for ~90% of the merchandise in 2018 and the company expects to continue to obtain a significant percentage of athletic product from these suppliers in future periods. Nike, being the biggest supplier, accounted for ~66% of all merchandise purchased in 2018. With the higher dependency on Nike, the company faces concentration risk and is exposed to the adverse effect of any unforeseen circumstances in Nike’s business in terms of financial or operations.

Considering the historical performance of the company for last 5 years, top-line has grown from $7151 million in FY2014 to $7939 million in FY2018. Net income witnessed a volatile performance by touching the highest profits of $664 million in FY2016. The company has enjoyed healthy margins with EBIT margins in the range of 7.4% to 13% and ROA in the range of 7.3% to 17.4% during FY2014-FY2018.


Five-Year Summary of Selected Financial Data (Source: Company Reports)

First Quarterly Results for 2019: The company recently, announced its first quarter results of 2019 wherein topline & bottom-line posted a little disappointment. The company delivered the net income of $172 million in 1Q19 compared to $165 million in the corresponding quarter last year. The quarter included the incremental charge of $1.0 million, which was due to the pension matter of the company. At the end of 1Q19, cash and cash equivalents stood at $1.126 billion, reflecting an increase of $97 million on pcp.

Diluted earnings per share (EPS) increased by 10.14% to $1.52 from $1.38 on pcp, during the period. Comparable store sales grew by 4.6% in the quarter. Meanwhile, the comparable sales gains by channel, FL’s stores increased by 2.9%. The company posted a 14.8% rise in the sales through its direct-to-customer channel and with this, direct-to-customer sales margin expanded to 15.4% during the period from 13.9% seen on pcp. This higher margin was on the back of recent investments made by the company. However, Store traffic declined by low-single digit, but the conversion improved. Additionally, FL invested about $45 million during the first quarter of 2019, which resulted in the opening of 14 new stores, comprising of two Power Stores and sixth store in Asia. The company had also remodeled or relocated 13 stores. With this, at the end of the 1Q19, FL closed 34 stores and is now operating with 3,201 stores which are owned by the company.


Q1FY19 Income Statement (Source: Company Reports)

Segment-Wise Performance during First Quarter of 2019: In North America, the company posted comparable sales gain in a low double-digit, driven by Champs Sports.  Brands Foot Locker US and Foot Locker Canada posted the comparable sales gain in mid-single digits and Eastbay posted the comparable sales gain in a low single-digit during the first quarter.

Internationally, almost all the divisions delivered comparable sales gains. Foot Locker Pacific had delivered the strongest performance as it posted the comparable sales rise in double-digits. Foot Locker Europe delivered the growth in a mid-single digit. Runners Point and Sidestep returned to growth, as both delivered the gain in low single-digit. However, Kids Foot Locker posted a decline in low single digit on the back of limited quantities available to the customers. Footaction fell to a high single digit on the back of weak demand in men's footwear business. Moreover, the footwear performed strongest as it posted the comp gain in a mid-single digit and apparel segment rose in low-single digits.

In the accessories business, the fashion bags performed excellently. Within the footwear segment, the women's business performed well during the first quarter of 2019 and delivered an increase in a low double-digit. Children's footwear grew in high single digit and men's section in the business rose in the mid-single digit.

By category, during the first quarter of 2019, men's classics delivered profit in double-digit and men's running segment grew in high single digits. The apparel segment, during the first quarter 2019 grew in the low-single digits, on the back of the men's business and posted the growth in mid-single digits. However, the women's business declined in low-single digits and children's business fell in low double-digit. The company experienced higher average selling prices in apparel in single digit during the first quarter.

Capital Management: During the first quarter of 2019, FL repurchased about 32,000 of its shares for the total value of $1.8 million. While the company limited the repurchase activity during the first quarter, it has come up with the new strategic plan. The company has planned to implement the share repurchase program of the total value of $1.2 billion and will be continued when appropriate. Moreover, FL increased the dividend by 10% to $0.38 over the previous dividend rate and has recently paid the total amount of $43 million.

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table which together form around 44.64% of the total shareholding.  The Vanguard Group, Inc., and AQR Capital Management, LLC hold the maximum interest in the company at 11.23% and 5.83%, respectively.  


Top 10 Shareholders (Source: Thomson Reuters)
 
Key Metrics: The company posted healthy margins in the first quarter of 2019. EBITDA and operating margins for the first quarter stood at 13.1% and 11%, which are higher than the industry median of 9.5% and 6%, respectively. Net margin at 8.3% in the quarter was higher as compared to the sequential basis, yoy basis, also above the industry median of 4.2%. ROE at 6.7% in the quarter was well-above 6.2% in the previous quarter, and significantly higher as compared to the industry median of 3.1%.


Key Ratio Metrics (Source: Thomson Reuters)  
 
Outlook for 2019: For the full year 2019, the company has become a bit conservative and revised the outlook downward. The company now anticipates the earnings per share to increase by high-single digits from previously forecasted double-digit growth.

Coming to the financial outlook for the remainder of 2019, during the second quarter, the company posted the lowest volume of the year with no big Call to Action shopping event. As a result, the company now expects comparable sales gain to be in the range of a low-to-mid single digit, and the gross margin is expected to be flat to down 20 basis points. For the full year 2019, FL expects to post the comparable sales gain to be in a mid-single digit, and there could be 20 to 40 basis points improvement in the gross margin. In the second quarter, the company expects the Selling, General and Administrative (SG&A) expense rate to rise by 80 to 100 basis points. The company projects depreciation to be about $185 million, and the effective tax rate for the full year is expected to be approximately 27.5%.


Key Valuation Metrics (Source: Thomson Reuters)
 
Financial Objectives till 2023: The company, in five years, projects the compounded annual growth rate (CAGR) for sales to be in the mid-single digit. Net income margin, during the period, is expected to be in high single digit. Sales per gross square foot is expected to be in the range of $525-$575 with return on invested capital to be in mid-teens and earnings before interest & tax margin to be in low double digits. Inventory turnover is expected to remain 3 to 4 times. Moreover, the company expects gross margin rate to increase and to be in the range of 32% to 33% from 31.8% in FY18. SG&A Rate is expected to be in the range of 18% to 19% from 20.3% in FY 18. Depreciation is also expected to be about 2% from the earlier 2.2% in FY18.


Projected Outlook (Source: Company Reports)

Valuation Methodology:

Method 1: PE Based Valuation (NTM):

PE-Based Valuation (Source: Thomson Reuters), *NTM-Next Twelve Months

Method 2: EV/Sales Based Valuation (NTM):

EV/Sales Based Valuation (Source: Thomson Reuters), *NTM-Next Twelve Months

Note: All forecasted figures and peers have been taken from Thomson Reuters, *NTM-Next Twelve Months

Stock Recommendation: Foot Locker, like many other retailers, is also reducing its store count. The company had earlier planned to close 165 stores globally in 2019. In the first quarter of 2019, the company closed 34 stores, though it had opened 14 new stores and remodeled 13 stores. FL’s stock had significantly fallen after the company posted results for the first quarter of 2019 and dimmed the outlook for 2019 with the conservative approach. However, the company is projecting improvement in the gross margin through fiscal 2023 and expects to reduce the expenses like SG&A and depreciation by 2023. The stock has corrected ~33% in the last 3-months, proffering a decent opportunity for accumulation. We are of the view that the stock has priced in most of the news flow and currently is trading at an attractive level. Based on the foregoing, we have valued the stock using the two relative valuation methods, Price Earnings multiple and EV to Sales multiple, and arrived at the target price in the ambit of $48.06 to $51.64 (low double-digit upside (%)). Hence, we recommend a “Buy” rating on the stock at the current market price of $40.81 per share, down 0.43% on 10 July 2019.


FL Daily Chart (Source: Thomson Reuters)

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