Shareholders of Foot Locker (NYSE:FL) must be feeling good these days. Its stock is up more than 10% since Aug. 18, when it announced second-quarter earnings that were nothing short of a 10. Can it keep it going? That’s for the markets to decide. What I do know is that expectations right now are sky high for a retailer with a history of fumbling the ball.
Recently, David Nelson, chief strategist of Belpointe Asset Management, wrote an article for Seeking Alpha that presented five reasons for owning Footlocker. I’ll use those same reasons to argue why you should do the opposite.
Management Outdoing Itself
Nelson believes Foot Locker’s management team is delivering sustainable growth. How are they doing this? CEO Ken Hicks, who left J.C. Penney (NYSE:JCP) in August 2009, unleashed a five-year growth plan in March 2010 that sought to differentiate Foot Locker’s various banners while moving it away from an unhealthy reliance on basketball shoes. In terms of numbers, the company looked to grow its international store base by 50% and increase its revenues from $4.9 billion in 2009 to $6 billion by the end of fiscal 2014.
Eighteen months into its five-year plan, and things seem to be going smoothly. Revenues for the trailing 12 months ended July 30 are $5.4 billion, just $600 million off its goal, and earnings are much better than in the past.
Where its plan is failing is in Europe, where the store openings aren’t happening nearly as fast as planned. At the end of fiscal 2009, Foot Locker had 518 stores in Europe. At the end of January 2011, that was up to 529. While the company doesn’t break out the quarterly numbers, the store total can’t be much more than 535 given the mess in Europe. With an estimated goal of 777 stores in Europe by January 2015, the company won’t come anywhere close to its target, which leads me to question its original revenue goal of $6 billion. Analysts seemed to think it was unrealistic. Now it appears Hicks was throwing a soft toss.
Analysts Raising Projections
Foot Locker’s second quarter was its sixth consecutive for revenue and profit growth. All were positive surprises, forcing analysts to raise full-year earnings per share for 2011 and 2012 to $1.70 and $1.91, respectively. Revenue estimates for January 2013 now sit at $5.77 billion, just shy of its $6 billion goal. Analysts have a price target of $26 on Foot Locker stock — 33% higher than where it’s currently trading.
My question, as always when it comes to analyst estimates, is why they are always so wrong when they are in contact with management on a weekly or even daily basis. Once they understood their projections were way off, what took them so long to adjust the numbers? These earnings surprises were born out of stubbornness.
Strong Athletic Cycle
A rising tide lifts all boats. Morningstar discussed the rebirth of running in an August article, suggesting that Foot Locker, Dick’s Sporting Goods (NYSE:DKS) and Hibbett Sports (NASDAQ:HIBB) are all benefiting from the sport, which is relatively cheap to participate in. Aging boomers are looking to keep in shape whether through running or walking, and athletic footwear is the prime beneficiary.
Nelson believes Foot Locker’s forward P/E of 10 is too low given the strength of this product cycle. Is he right? Both Hibbett and Dick’s forward P/E are above 14, so he definitely has a point. However, Dick’s and especially Hibbett’s have far superior returns on invested capital. Either they’re all undervalued or none is. I tend to think it’s the latter.
See the previous paragraph.
This last one has me a little confused. Nelson suggests Foot Locker’s dividend yield of 3.7% is 85% higher than the S&P 500. However, the index’s current yield is 2.3%, making the real number more like 61% higher. What I believe he meant to say is that Foot Locker’s current yield is higher than 85% of the stocks on the S&P 500. Since the article appeared on Aug. 22, both Foot Locker’s yield and its position amongst the S&P 500’s top yielding stocks have dropped. It’s still attractive, but a tad less so.
Foot Locker’s stock has appreciated threefold since its low in late 2008. Its summer swoon, given its lengthy 30-month run, seems more than warranted. At this point, I’m inclined to think its stock will remain in the $20 range for some time. It’s anything but a buy.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.