A lot of these companies have already reported earnings and the numbers have broadly been solid. Yet, despite strong numbers, investors are dumping most retail stocks after earnings because the market is taking a cautious outlook on future economic growth.
That isn’t great news for Foot Locker (NYSE:FL).
The athletic apparel retailer is set to report third-quarter earnings after the bell on Tuesday, Nov. 20. The numbers should be pretty good. But, if FL stock follows the precedent set by its retail peers, this stock could be due for a post-earnings collapse.
I don’t think that will happen.
Foot Locker’s numbers should be pretty good, and FL stock is pretty cheap. In a normal market, pretty good numbers on a cheap stock usually result in a rally. Granted, this isn’t a normal market. Everyone is concerned about a looming recession. But, the near-to-medium-term growth drivers at Foot Locker are simply too good, and the valuation on FL stock simply too cheap, for investors to disregard the bull thesis in the event of strong quarterly numbers.
As such, if Foot Locker delivers on strong Q3 numbers as I expect them to, then FL stock could buck the broad retail trend and bounce back.
All Signs Point to Strength at Foot Locker
Foot Locker’s third-quarter numbers should be quite good for three big reasons. One, niche U.S.-focused retailers are reporting really good numbers, a reflection of continued domestic consumer strength. Two, the entire athletic apparel space is still red hot. Three, Nike (NYSE:NKE) is making a major comeback, and Foot Locker has a ton of Nike exposure.
On the first point, while the stock market reaction to retail earnings has been negative, there is no denying that domestic retail numbers have been very strong. Walmart (NYSE:WMT) reported a robust 3.4% rise in U.S. comparable sales in Q3. Target reported a 5.1% comparable sales increase in the same quarter. Granted, the market didn’t like either Walmart or Target’s Q3 reports because of weakness elsewhere.
But, the market did like reports from more niche, U.S.-focused retailers like Urban Outfitters, who also reported strong domestic numbers. Foot Locker falls more in the Urban Outfitters category than the Walmart/Target category, and as such, the outlook for good numbers to power a post-earnings rally is favorable.
On the second point, everyone in the athletic apparel space from Nike to Under Armour (NYSE:UAA) to Adidas (OTCMKTS:ADDYY) to Lululemon (NASDAQ:LULU) is reporting really good numbers. Also, Piper Jaffray’s Taking Stock With Teen Survey found that athletic apparel remains on an uptrend and is the go-to clothing choice for teenagers.
This is all good news for Foot Locker. The more consumers buy athletic apparel clothing, the more often they will wind up in a Foot Locker store or on Foot Locker’s website. This is especially true considering that the same Piper Jaffray found that Foot Locker’s mind-share as a footwear shopping destination is growing.
On the third point, Foot Locker is essentially Nike’s footwear retailer. Last year, about 70% of Foot Locker’s product was sourced through Nike. Thus, as goes Nike, so goes Foot Locker.
Nike is on fire right now. Last quarter, the company reported 9% constant currency revenue growth, including 6% constant currency revenue growth in North America and 5% growth in North America footwear. Those are multi-year high growth rates for Nike. As such, considering Foot Locker is 70% Nike, investors should expect multi-year high growth rates from Foot Locker, too.
Valuation Is Compelling
Foot Locker’s third-quarter numbers should be quite good. But, will they be good enough to spark a rally in FL stock? I think so. FL stock is simply too cheap for strong numbers not to spark a big rally.
Let’s look at the retail stocks that have dropped over the past week despite strong quarterly numbers. You have Walmart, which was trading at over 20X forward earnings into the report. There’s Target, which was trading around 16X forward earnings, and Home Depot (NYSE:HD), which was at 19X. Macy’s (NYSE:M) was at just 8X forward earnings, but that company has a huge debt problem, and that is of increasing concern as rates rise.
Now, let’s look at FL stock. It is trading at just 10X forward earnings ahead of Q3 earnings. That is dirt cheap and way cheaper than where everyone besides Macy’s was trading before their Q3 reports. But, Macy’s balance sheet is loaded with debt. Foot Locker’s balance sheet isn’t. Last quarter, Foot Locker’s cash on hand outnumbered debt by more than sevenfold.
In other words, because of its dirt cheap valuation and super clean balance sheet, it is tough to see strong quarterly numbers leading to a poor reaction in FL stock. Look at URBN stock. That stock was trading at 13X forward earnings heading into the Q3 report, has a clean balance sheet, delivered strong numbers, and the stock popped.
The same thing should happen with FL stock.
Bottom Line on FL Stock
Retail stocks have been big losers this earnings season. But, given an already depressed valuation, strong fundamentals, and clean financials, FL stock should be able to buck that trend.
As of this writing, Luke Lango was long FL, NKE, WMT and M stock.