Once again, my favorite mall-based retailer, Foot Locker (NYSE:FL) posted terrific Q4 results that sent shares surging higher. The "retail is dying" thesis does not apply to Foot Locker as it continues to leverage its position as a brand-agnostic seller of sneakers that is capitalizing on a long-term secular tailwind. I am upgrading my fair value estimate for the share price to $85. Shares continue to represent one of the best investment options in the retail space.
Q4 Financial Overview
Fourth quarter sales jumped 5.3% y/y to $2.1 billion driven by a 5% increase in same-store sales. On an adjusted basis, earnings per share grew 18% y/y to $1.37 per share as the company saw an increase in merchandise margins and leveraged SG&A expenses. Gross margins for the quarter jumped 10 basis points y/y thanks to the 20 basis point increase in merchandise margins driven by strong ASPs and a mix shift to premium apparel products, though Foot Locker did experience 10 basis points of occupancy deleverage. Below the gross margin line, SG&A declined 60 basis points y/y to 18.7% of sales as the company did a wonderful job of managing variable costs like wages and marketing expenses. On an absolute basis, Foot Locker added just $7 million in SG&A costs versus a $38 million increase in gross profit dollars. There is a lot of leverage in the Foot Locker business model, and we are seeing it translate to growing profitability.
Health of the Sneaker Business
Over the past several months, there have been numerous reports about the decline of the sneaker market, as Nike (NYSE:NKE) has notably experienced a loss in momentum in its signature basketball sneakers like the LeBron, KD, and Kobe lines. The LeBron XII and XIII failed to capture the momentum of the LeBron VII-XI, and with the line under pressure, retailers have seen a significant mix shift away from performance basketball. Additionally, performance running has struggled to see its styles translate into casual wear the past 2-3 years. With these factors away from performance footwear in play, analysts have been terrified that the growth of the sneaker business has come to end.
However, Foot Locker continues to prove that is not the case. Led by a resurgent Adidas (OTCQX:ADDYY), casual and retro sneakers have come to the forefront, with styles like the adidas NMD, Stan Smith, and Superstar driving significant growth. Ultimately, classifying different styles of shoes has always struck me as a misrepresentation of the market. Technically, Jordan Retro shoes are "basketball" sneakers, but in practice, they are worn casually the vast majority of the time. In my view, and in the view of Foot Locker CEO Dick Johnson, it is much more important to have the right assortment of product rather than it is to focus on arbitrary style distinctions.
Johnson elaborated brilliantly on this point, and I think it speaks to the holistic approach that is necessary to analyze the athletic footwear market. Johnson said:
"First, from a casual perspective, I think it's important to remember that virtually the vast majority of our shoes are sold from a casual hook-up to what I'm wearing today sort of mindset for our consumer. So again, Superstars in basketball, Huaraches in running, all of those sneakers are viewed - we put them in categories, but just the same way that our customer doesn't think in channels, they don't really think in categories.
So wherever the heat is brought by our tremendous vendor partners, the consumer is going to move there. Whether they decide to play basketball in a basketball shoe or they decide to hang out on the street with their friends, they're the ones that ultimately make the determination. So, I don't want to get into sort of the crystal-balling of how each category will respond. I have a huge amount of faith in our vendor partners and our merchant teams to move the dollars where the customer is and is going to be."
Johnson's quote speaks to the versatility of the Foot Locker business model. It doesn't really matter what product category is leading the way -as long as consumers are eager to buy the newest and most fashionable sneakers, Foot Locker is able to move the product.
Location and innovation
In a stark contrast to Finish Line (NASDAQ:FINL), which is closing around 25% of its stores and is struggling to execute its online strategy, Foot Locker has excellent store locations, and it selectively editing its footprint-but not overwhelmingly shrinking it. Why? I think this is because Foot Locker has a much more diverse storebase (urban & mall-based) than Finish Line, which is heavily concentrated in malls with fewer standalone stores.
Additionally, Foot Locker has invested heavily in having a strong digital channel. Digital sales at all banners jumped over 20% y/y in North America for 2016 and accelerated even faster OUS.
Increasing Fair Value Estimate
Due to the combination of strong guidance that improves my near-term projections and the time value of money, I am increasing my mid-point fair value estimate for shares of Foot Locker to $85. Foot Locker's earnings per share is set to grow at least 10%, so I am projecting earnings of about $5.50. This translates to a PE of about ~15-16x, which seems relatively conservative given Foot Locker's near-decade long run of strong performance. Truthfully, were Foot Locker not associated with other retailers, I believe shares would trade at a much higher multiple. Alas, investors are able to own the company at a reasonable price, enjoy generous returns of capital, and likely a solid return via share price appreciation.
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.