Foot Locker (NYSE:FL) earnings on Tuesday afternoon are going to be huge. Foot Locker stock has trading mostly sideways for 2018 after FL stock rallied strongly from a five-year low last November. The chart seems to show a market waiting for something to happen — and that ‘something’ likely will be Tuesday’s report.
It’s not just an important report for FL stock, either. As I wrote on Friday, Foot Locker earnings could reverberate across the market. The company’s sales are a good proxy for mall traffic: if FL stock falls in trading Wednesday, other mall-heavy retailers may follow. Investors in key suppliers like adidas (OTCMKTS:ADDYY), Under Armour (NYSE:UA,UAA), and particularly Nike (NYSE:NKE) will also watch Foot Locker earnings closely.
But Tuesday’s report is particularly important for Foot Locker. Options markets are pricing in a ~14% move in FL over the next month, and that may even prove to be conservative. Foot Locker has a number of tailwinds at its back. If it can’t grow sales and profits this holiday season, it’s possible that it never will again. And even a seemingly soft 9x earnings multiple (backing out net cash) has to come down.
If Foot Locker posts a strong Q3, however, and tips a good Q4, suddenly Foot Locker looks like an important, if not vital, part of the sneaker ecosystem. And judging by how well that category is performing of late, that implies big — and potentially huge — upside in Foot Locker stock.
Foot Locker Earnings Expectations
The good news for FL stock heading into the Q3 report is that expectations are low. Consensus estimates are for a sales decline of 1.1%, and EPS growth of just 6%, which implies a double-digit drop in pre-tax profit. It’s not going to take much for Foot Locker earnings to beat the Street.
Q4 guidance, given the importance of the holiday season, may be more important. There, too, estimates look soft. After Q2, Foot Locker management guided for strengthening same-store sales in the back half. If the company hits that bogey, the numbers almost certainly come in above expectations on Tuesday afternoon.
Despite the soft numbers, the same analysts making those estimates still seem reasonably bullish. Jefferies and Wells Fargo both have come out with positive notes on FL stock in recent weeks. The average Street target price of $56.48 suggests 14% upside.
All told, there’s clearly a path for nice gains in FL stock coming out of the report. A good print for Q3 and strong guidance for Q4 gets the Street more loudly behind the stock. Raised full-year expectations — to, say, $4.70 from a current $4.48 — and a higher 11-12x P/E multiple, plus cash, gets FL stock closer to $60.
Why FL Stock Could Climb After Earnings
And there are reasons to see a strong print on the way. Foot Locker earnings beat expectations in both Q1 and Q2. Looking forward, sales and earnings should be solid in the back half, for several reasons.
For one, the sneaker category has shown renewed strength this year. Nike alone supplies 67% of merchandise, according to the FL 10-K. As Luke Lango and Tom Taulli argued here and here, that resurgence should provide a boost for Foot Locker as well.
Secondly, other public footwear retailers are showing that the e-commerce threat in the space may have been overblown. Shoe Carnival (NASDAQ:SCVL) has had a fine year, with its stock up almost 50% from May levels thanks to a pair of earnings beats. DSW (NYSE:DSW) hasn’t traded as well, but it posted a strong fiscal Q2 report and raised full-year guidance.
And, third, the economy is strong. Unemployment is low, and consumer confidence is high. Sneakers aren’t necessarily a discretionary purchase — but the $200+, high-demand, high-margin models from Nike and adidas generally are.
In that context – and given guidance for positive comps in Q3 and Q4 – expectations look too low. And Foot Locker looks set up for a beat that could change the trajectory of the stock. Strong results emphasize that Foot Locker is a key partner to Nike, in particular, not a competitor as that supplier ramps up its own DTC business. And they contradict some of the fears around mall traffic and broader e-commerce sales that are keeping a lid on Foot Locker stock.
But those tailwinds also set up potentially huge downside in FL stock as well.
The Nightmare Scenario for Foot Locker Stock
If Foot Locker earnings for the second half disappoint, what then? If Foot Locker same-store sales are negative in Q3 — and/or guided that way for Q4 — there’s nothing else to blame but the business model. The category is strong. Other footwear retailers are managing e-commerce competition. The problem in that scenario is simple and clear: customers won’t go to the mall, even to buy the sneakers they want.
And there is literally nothing Foot Locker can do about that. Lower-margin e-commerce sales aren’t going to offset that trend, not with the company competing against Nike itself, not to mention Amazon.com (NASDAQ:AMZN) and other online retailers. If second-half results disappoint, the question becomes: if Foot Locker can’t grow sales when the category is hot and the economy is strong, what happens when at least one of those tailwinds eventually fades? If comps don’t grow in 2018, when will they?
The answer is: potentially never. And as cheap as FL stock looks at the moment, that is devastating to the bull case here. Bear in mind that operating leases are going on the balance sheet next year, due to accounting changes. Those leases had a present value of $3.73 billion at the end of 2017, per the 10-K. With that on the balance sheet, there’s no reason a declining business can’t get a 7-8x multiple. That multiple in turn sends FL stock reeling toward November lows around $30.
Simply put, this is a huge second half for Foot Locker. And the Q3 report could shape the mid- to long-term trajectory of Foot Locker stock. Is Foot Locker a permanent part of the sneaker economy or a fading retailer whose best days have passed? Investors and analysts will be much more confident answering that question on Tuesday evening.
As of this writing, Vince Martin has no positions in any securities mentioned.