I feel like I could save myself a lot of time and effort and simply assume that the world's dominant footwear retailer, Foot Locker (NYSE:FL), will simply beat estimates every quarter. Foot Locker once again crushed estimates for its third quarter, with revenue up 5.6% y/y to $1.9 billion and adjusted EPS up 13% y/y to $1.13 per share-a robust 3-cent beat.
Based on Foot Locker's Q3 results, I am upping my fair value to $77 from $75 based on slightly more optimistic sales projections. Let's take a look at the quarter, the highs and lows, and the implications on other companies mentioned during Foot Locker's conference call.
Q3 by the numbers
Foot Locker's Q3 results were outstanding, and as you may have guessed, this performance was largely driven by comps. Same-store sales grew 4.7% y/y-an excellent number but even more impressive when measured against last year's 8.7% comp in Q3. This equates to a 2-year stacked cop of 13.4%, and if we throw in Q3'14 for good measure, Foot Locker's 3-year stacked comp is a whopping 20.3%. Stores have become incredibly more productive, and as a result, gross margins have increased from 33.2% in Q3'14 to 33.9% in Q3'16. This led to an incremental $66 million in gross profit.
The strength in Q3 was fairly broad-based, highlighting the diversity of Foot Locker's business. Nike (NYSE:NKE), adidas (OTCQX:ADDYY), and Puma casual and casual running were all up nicely in the quarter in spite of a slight decline in basketball sales. In basketball, adidas retro styles like the Superstar were strong, as was the Nike Kyrie 2 and the Under Armour (NYSE:UA) Curry 2 and Curry 2.5. Of note, management spoke to a weak launch and uptake for the Curry 3, saying on the call:
"The 3.0 is fairly new into the business. It started off a bit slower than the 2 previous models. But again, it's early days. And I think their commitment to the footwear business, they've got a great asset in Steph Curry obviously and they expand their asset base as well beyond Curry. The thing that we all want to see them have is a multi-platform footwear business. And Curry is certainly in the lead. And we're optimistic that they're going to be able to continue to keep that platform with some momentum behind it and certainly expand their footwear offerings."
While this nugget clearly weighed on Under Armour's share price, I do not believe this is new news. My fellow Seeking Alpha contributor L&F Capital Management called it earlier this week, and it is something I have certainly noticed in my research. UA is a lot more than just the Curry line, and the Curry line is a lot more than simply its performance in the US, so I am not terribly concerned about this data point impacting the firm's long-term valuation.
From a product mix standpoint, I didn't hear much that suggested a turn in basketball is coming any time soon. CEO Richard Johnson was confident in adidas' ability to leverage its Harden product and noted the blip of success from the Nike KD 9 upon release, but overall, it sounds like basketball could be weak for a while. And that's ok-because like many money managers, Foot Locker is an indexer, and as long as the footwear market performs well, Foot Locker will be a beneficiary.
On the SG&A front, costs fell 20 basis points y/y as a percentage of sales to 19.4%. I do not anticipate this trend to continue as Foot Locker will continue to battle labor headwinds; however, operating margins should be maintained thanks to continued store productivity growth.
Foot Locker, unlike many retailers, has an intimate understanding of its consumer. Johnson demonstrates this knowledge time and time again, and I greatly appreciated his monologue on the latest earnings call. Johnson said:
"Authenticity is a key concept in connecting with the customers, who are affectionately called sneakerheads, those who buy the most sneakers and who set or influence of the athletic footwear and apparel styles for their peers. We strive to be authentic with our customers in the products we showcase and the quality of the physical spaces they shop in and the seamlessness of the digital interaction we have with them and in the knowledge and enthusiasm of our associates as they engage with our customers each and every day."
Simply knowing that a CEO knows his customers so well gives me a great deal of faith in his or her ability to run the company. The above quote specifically relates to how the company will be using its new flagship NYC concept to test ideas and remain on the cutting edge of footwear design. Assuming positive results, I suspect the company will allocate capital towards investing in the format elsewhere. The company should spend $290 million on capex in 2016, which I believe is a suitable number to continue to improve store productivity.
On the repurchase front, the company bought back $76 million worth of stock, which seems reasonable given Foot Locker's current valuation is in-line with its historical comps. Like clockwork, Foot Locker has raised its quarterly dividend every year since 2004. Foot Locker's dividend payment will likely increase to $0.30/quarter in 2017, equal to a yield of ~1.6% at current prices.
Upgrading fair value to $77
After this terrific quarter, I am adjusting some of my near-term assumptions, and I have increased my fair value to $77. I think shares can easily trade to $77 after Foot Locker posts another great fourth quarter. 7.9% growth in Q4 of last year will not be easy to top, but I think mild weather thus far in Q4 coupled with strong product launches will drive a 5-6% comp, driving better than expected earnings growth.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FL over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.