Foot Locker: Evaluating the Value of This Stock Investment
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Chapter 1: Overview of Foot Locker
Foot Locker is a prominent name in the athletic footwear and apparel market, currently trading at a price lower than its book value. This suggests that the stock is relatively inexpensive. However, being low-priced does not automatically equate to being a wise investment. In this assessment, I will outline my perspective on Foot Locker and evaluate its potential as an investment choice.
Disclaimer: This is not financial advice. I am not a financial advisor. My intention is to share my analysis and decision-making process. For anyone considering investing, it’s crucial to perform your own research or consult with a qualified financial advisor, as all investments carry risks of loss.
Section 1.1: Company Background
Founded in 1974, Foot Locker operates 2,523 retail locations across 26 countries, including North America, Europe, Asia, Australia, and New Zealand. Additionally, the company manages 202 franchised stores in the Middle East and Asia, along with various websites and mobile applications. Besides the flagship Foot Locker brand, it owns several other brands, including Kids Foot Locker, Champs Sports, atmos, and WSS. Management asserts that Foot Locker boasts a significant brand advantage, or "moat," evidenced by its 12 million followers on Instagram—five times more than those of its top competitors. A third-party analysis also indicates that Foot Locker's brand health index exceeds the average in its sector by 20%. This strong brand positioning and loyal customer base have allowed Foot Locker to cultivate beneficial relationships with its suppliers.
Section 1.2: Leadership Profile
Mary Dillon serves as the CEO, having taken the helm in September 2022. Before joining Foot Locker, she held the CEO position at Ulta Beauty and has experience with major companies like McDonald's and PepsiCo. She also sits on the Board of Directors at KKK & Co, a global investment firm. Dillon holds a degree in Marketing and Asian Studies from the University of Illinois and has demonstrated a strong work ethic throughout her career. Notably, during her tenure at Ulta, she tripled the company's market cap and doubled its revenue over eight years. Her appointment as Foot Locker's CEO was met with a 20% surge in stock prices, signaling investor confidence in her leadership.
Chapter 2: Financial Performance
The financial metrics we will examine include the return on invested capital (ROIC) and free cash flow. An ideal ROIC history spans ten years, consistently exceeding 10%. Foot Locker has successfully maintained a ROIC above this threshold until fiscal year 2022 but fell just below 10% in 2023 and recorded a negative figure in 2024. While the macroeconomic environment has posed challenges, a negative ROIC is troubling. I will be closely observing Foot Locker’s performance through fiscal year 2025 to see if it can rebound.
Free cash flow, which represents the cash available after operational costs and capital expenditures, is another critical metric. Foot Locker has generally posted positive free cash flow for eight out of the last ten years; however, it reported negative figures for the past two years. The levered free cash flow margin had been stable prior to the pandemic but declined sharply in 2022, remaining negative since then. This trend raises concerns regarding the company's valuation and financial health.
Section 2.1: Debt Considerations
Evaluating the company’s debt is vital to understanding its financial stability. A manageable debt level should allow repayment within three years. While 2024 figures show negative earnings, using non-GAAP numbers indicates a debt-to-earnings ratio of 2.9 years. For fiscal 2023, this ratio was a more favorable 1.3 years, suggesting that Foot Locker's debt is at an acceptable level for prospective investors.
Section 2.2: Risks to Consider
Investing in Foot Locker comes with inherent risks. Competition in the retail athletic footwear sector is fierce, with Foot Locker facing threats from specialty stores, online retailers, and suppliers who are increasingly focusing on direct-to-consumer sales. For example, Nike, which supplies roughly 65% of Foot Locker's merchandise, is prioritizing its own retail channels, leading to declining revenues for Foot Locker.
Moreover, managing inventory effectively is crucial. The company must balance sufficient stock levels without over-accumulating, which can lead to markdowns that adversely affect profit margins. Foot Locker has struggled with inventory management, particularly following the pandemic, when it miscalculated consumer demand and is now selling excess stock at reduced prices.
Macroeconomic conditions also impact performance, as the company’s results are sensitive to shifts in consumer spending patterns. Current economic uncertainties have led to reduced expansion plans, particularly for its WSS brand, which serves a rapidly growing consumer segment.
Chapter 3: Investment Opportunities
Despite these challenges, there are compelling reasons to consider investing in Foot Locker. The management team is focused on expanding sneaker culture by enhancing product variety and marketing strategies, aiming to increase sneaker market penetration from 40% to 47% by 2026. Their global initiative, "The Heart of Sneakers," promotes the idea that sneakers are more than footwear and has already seen successful engagement on social media platforms.
The company is also making strides in its digital sales strategy, which now accounts for nearly 20% of revenue, up from 18.2% the previous year. Foot Locker plans to launch a new mobile app in fiscal 2025 to further improve customer engagement and loyalty, with aims for 25% e-commerce penetration by 2026.
Additionally, the FLX loyalty program is showing promise, with positive initial responses in Canada. Management plans to expand this program across North America and globally, targeting a 50% loyalty penetration by 2026, which could drive increased sales and customer retention.
Chapter 4: Valuation Insights
Now let's consider the share valuation. I utilize three different calculations learned from a Phil Town seminar. For those interested, you can access the calculators on my website.
The first calculation is the Margin of Safety price, based on earnings per share (EPS), anticipated growth rates, and price-to-earnings ratios. With Foot Locker reporting a negative EPS in 2024, I opted for a non-GAAP EPS of 1.42, a projected growth rate of 8%, and a price-to-earnings ratio of 16. The calculated intrinsic value is $12.12, leading to a target buy price of $6.06 when considering a 50% margin of safety.
The second valuation method, the Ten Cap price, reflects the expected return on investment. Using fiscal 2023 data, the calculated Ten Cap price stands at $16.30.
Due to the negative free cash flow in recent years, I am unable to perform the Payback Time price calculation.
Conclusion: A Cautious Outlook
While Foot Locker faces significant hurdles, particularly regarding management changes, inventory control, and competitive pressures, I remain optimistic about the new CEO's potential to revitalize the company. The past two years of negative ROIC and free cash flow are concerning, compounded by competition and macroeconomic influences.
Nonetheless, initiatives to expand sneaker culture, enhance digital sales, and launch an effective loyalty program signal potential for growth. However, considering the current risks, I have decided against investing in Foot Locker at this time.