Shares of Foot Locker (NYSE:FL) rose sharply on Friday after the athletic footwear retailer reported fourth-quarter numbers which smashed expectations. Management also gave a far-above-consensus guide for fiscal 2019 comparable sales and profit growth. Investors cheered the positive news. FL stock rallied more than 5% in response.
In the big picture, the double-beat-and-raise fourth-quarter earnings report is further confirmation that Foot Locker is back. Consider the following: Foot Locker just reported its biggest EPS beat in a year. It was also the company’s biggest revenue beat in several years, and its biggest comparable sales gain in recent memory. Margins are rebounding. Profit growth is back. Further, Foot Locker has now rattled off four consecutive double-beat quarters. That hasn’t happened since 2015, when FL stock was a high-flyer on a winning trajectory.
Clearly, Foot Locker is getting back to its old self, circa 2015. That’s great news for FL stock. Back in 2015, FL was a $70 stock trading at a 16 trailing P/E multiple. Today, FL is a $60 stock trading at a 13.5 trailing P/E multiple.
Thus, if Foot Locker can continue to get its groove back in 2019, history says that FL stock has ample room to run higher from a combination of earnings growth and multiple expansion. This is exactly what will happen. As such, investors shouldn’t take profits just yet. FL stock is up over 50% over the past year, and it could rally another 15% over the next year.
Strong Q4 Numbers Confirm The Rebound Thesis
Foot Locker’s fourth-quarter earnings report was very good. Comparable sales rose nearly 10%, their biggest gain in recent memory and a sharp change of pace from the 3.7% drop in comparable sales in the year ago quarter. Gross margins expanded roughly 100 basis points year-over-year, continuing a multi-quarter streak of gross margin expansion. Meanwhile, although the SG&A rate rose, it rose by just 70 basis points year-over-year, its slowest expansion since Q1.
In other words, everything is moving in the right direction for Foot Locker. Comparable sales growth is accelerating higher. Gross margins are rebounding. Opex rates are stabilizing. All of this is expected to continue next year. Comparable sales growth is expected to be in the mid-single-digit range, while profit growth is expected to be in excess of 10%.
These strong numbers corroborate the FL stock rebound thesis. That thesis is pretty simple. The athletic retail landscape has undergone a dramatic shift from wholesale to direct. That shift had a negative impact on athletic apparel wholesale partners like Foot Locker. But, this shift was never going to kill the wholesale segment, since athletic brands like Nike (NYSE:NKE) need a sizable wholesale presence to optimize reach.
As such, this shift was just a downsizing of the wholesale sector, wherein athletic brands pulled product from low-value and low-reach wholesale partners, and put that product into a split between their own direct channels and high value, high reach wholesale partners. Foot Locker is one of those high value, high reach players. Consequently, while the company felt the pain from wholesale downsizing in 2017, they are now reaping the rewards of increased market share.
They will continue to reap these rewards in 2019 and thereafter. Growth will stabilize as the wholesale downsizing process now seems to largely be in the rear-view mirror. Margins will improve because there is now less wholesale competition. Profits will rise. So will FL stock.
Foot Locker Stock Remains Undervalued
As stated earlier, Foot Locker has now rattled off four consecutive double-beat quarters. The last time the company did that was in 2015. Back then, FL stock was trading at 16X trailing earnings. Today, the stock trades at just 13.5X trailing earnings. On that comparison alone, you could argue that FL stock is undervalued.
And you would be right.
At current levels, FL stock is undervalued considering that Foot Locker is back to growing at a stable rate. Over the next several years, the old Foot Locker should re-emerge from the ashes. That means steady and healthy positive comps, margin expansion, and profit growth. In sum, that growth profile should drive EPS towards $8 by fiscal 2025.
Based on a historically average 13X forward multiple, that implies a fiscal 2024 price target for FL stock of over $100. Discounted back by 8% per year (two points below my normal 10% discount rate to account for the yield), that equates to a 2019 price target of just over $70, versus a $60 price tag today.
Bottom Line on FL Stock
Foot Locker is back. After a few rough years of sluggish growth, the old Foot Locker is re-emerging from the ashes, and that implies that healthy growth will be the norm going forward. If so, FL stock has runway to $70 in 2019, meaning that it still isn’t too late to buy into this rebound story.
As of this writing, Luke Lango was long FL and NKE.