Although most retail stocks have been bouncing lately thanks to a very strong consumer environment, there’s one retailer out there that still has stinky feet. That retailer would be Foot Locker (NYSE:FL).
The athletic footwear retail giant recently reported second-quarter numbers that came in well above expectations. But the market wasn’t impressed, likely because the company is spending a whole bunch to drive sales growth that still isn’t up to par with the whole retail industry. As such, FL stock dropped more than 10% after the second quarter print.
History says buy the dip here. So do fundamentals. Technicals say buy the dip, too.
Thus, I think this recent sell-off in FL stock is an opportunity to buy the dip. Here’s a deeper look.
Foot Locker’s Earnings Report Wasn’t Perfect
The market didn’t like Foot Locker’s Q2 earnings report because comparable sales growth was weak, and the company had to spend a bunch of money to drive that weak comparable sales growth.
Namely, comparable sales growth was just 0.5% in the quarter. By comparison, retail sales across the whole U.S. rose 6% in the roughly overlapping period, and big retailers like Walmart (NYSE:WMT), Target (NYSE:TGT), Macy’s (NYSE:M), Nordstrom (NYSE:JWN) and Kohl’s (NYSE:KSS) all reported comparable sales growth last quarter that was roughly 3% or higher. Indeed, the only other major retailer that reported 0-1% comparable sales growth last quarter was J.C. Penney (NYSE:JCP), and that is an awful comparison.
Moreover, Foot Locker spent an arm and a leg to drive that anemic growth. The SG&A rate rose 140 basis points in the quarter, a direct result of investments into the business which were meant to catalyze renewed revenue growth.
Overall, then, Mr. Market had his reasons to be disappointed in Foot Locker’s Q2 print. It wasn’t a perfect quarter, and many investors were expecting perfect after what peers had reported earlier in the week.
But The FL Report Showed Improvement
In the big picture, Foot Locker’s Q2 report wasn’t perfect, but it was a big step in the right direction.
Yes, comparable sales growth was weak at just 0.5%. But, at least it was a positive. This is a company that has been plagued by negative comparable sales growth for several quarters now. Thus, comparable sales growth returning to positive territory this quarter signals that the company is on the right track.
Moreover, management expressed confidence about bigger and better comparable sales growth in the back-half of the year thanks to strong product pipelines from Nike (NYSE:NKE) and Adidas (OTCMKTS:ADDYY).
Also, yes, the SG&A rate rose by a whole bunch, and that diluted profit growth. But, on the flip side, gross margins are bouncing back. Much like comparable sales growth, gross margins had been falling back for several quarters. In Q2, though, they rose 60 basis points, yet another sign that the company is on the right rack.
Overall, Foot Locker’s quarter wasn’t perfect. But, it did show dramatic improvement. Comparable sales growth is back in positive territory and gross margins are finally rebounding. So long as those two metrics continue to improve, FL stock should head higher considering its relatively cheap valuation (10x forward earnings) and clean balance sheet ($950 million in cash and less than $125 million in debt).
It’s Time To Buy Foot Locker Stock
My numbers suggest that FL stock is materially undervalued at $46 and change. This is a company which has historically grown revenues at a mid-to-high single digit rate, posted consistent gross margin expansion, and driven its opex rate down amid strong sales growth. Granted, the industry is changing, and Foot Locker won’t repeat on its earlier successes.
But, going forward, Foot Locker will remain an important part of the athletic footwear distribution model due to its deep connections with athletic apparel companies like Nike. Thus, Foot Locker should be able to post low single digit revenue growth going forward, alongside mild margin expansion. Under those assumptions, I think Foot Locker can net earnings per share of $6.20 in five years.
A historically average 13x forward multiple on $6.20 implies a four-year forward price target of ~$81. Discounted back by 10% per year, that equates to a year-end price target of ~$60. Therefore, at $46, FL stock is materially undervalued, according to my numbers.
Also, FL stock has been on a roller coaster ride for the past year. During that stretch, FL stock has dropped 20% or more off its 52-week high three times (November 2017, March 2018, and May 2018). Each time, the stock rebounded in a big way.
The current sell-off puts FL stock more than 20% off its 52-week high. And so, history says a rebound is coming.
On the technical side of things, FL stock has dropped to its 200-day moving average. Normally, this is the last line of technical defense for a stock. If this line holds, then a rally in FL stock will likely follow.
Bottom Line on FL Stock
Foot Locker’s quarter wasn’t perfect, but it did show that the company is heading in the right direction. At 10X forward earnings, all FL stock needs is “heading in the right direction” to sprint higher.
As of this writing, Luke Lango was long FL, M, and KSS.