The shopping season rally was short-lived. Foot Locker's (NYSE:FL) unimpressive holiday quarter results, a rarity in retail nowadays, have sent the company's stock back into the red for the trailing 15-week period, following the earnings-driven recovery of mid-November 2017.
(Image Credit: Seeking Alpha)
Revenues of $2.21 billion were not high enough to top mildly more optimistic consensus expectations of $2.22 billion, driven by worse-than-expected comps. Meanwhile, EPS of $1.26 beat consensus, but not by much at all. Perhaps driving share price weakness the most was a 2018 outlook that, while not disastrous, pushed hopes for improvement towards the back end of the year.
Not helping to support bullish sentiment were FX tailwinds, without which Foot Locker's sales would have been about two and a half percentage points lower. In addition, gross margin of 31.4% landed a discouraging 240 bps below year-ago levels, reflecting what management has called "a highly promotional marketplace environment." Non-GAAP op margin took an even larger hit, as opex grew at a faster pace than revenues. Lastly, an effective tax rate of only 32.0% contributed to what I calculate to be a six-cent benefit to EPS over 4Q16 levels, which I believe will be discounted by investors as non-operating tailwinds that speak little to the health of the business.
See my summarized, non-GAAP P&L below.
(Source: D.M. Martins Research, using data from company reports)
My takeaways
The results of the holiday quarter seem to be aligned with what I expect to see of Foot Locker: (1) top line challenges that, because of pricing softness, should (2) impact gross margins negatively, along with (3) opex pressures to support sales activity at acceptable levels (including the digital channel). This dynamic does not seem very encouraging to me.
On a more positive note, management's timid optimism over more resilient margins in 2018 might prove accurate, considering Foot Locker's inventory continue to be flushed out at discounted prices - merchandise was down -2% YOY by the end of 2017. In addition, the balance sheet continues to look healthy, with a net cash position of $724 million accounting for nearly 30% of book equity. Finally, FL looks inexpensive at a forward P/E of only 9.0x and PEG of 1.6x - the latter being largely on par with peers Finish Line (FINL) and Dick's Sporting Goods (DKS).
FL PE Ratio (Forward) data by YCharts
However, I continue to be skeptical that Foot Locker will be able to thrive amid the challenges of the e-commerce revolution and the "death of the mall" phenomenon. I have no reason to doubt that sporting goods companies will continue to do well in the long term. But I believe the odds are stacked in favor of the suppliers who have the ability to market directly to the end consumer - Nike (NKE) being one of the first names that come to mind.
Note from the author: I do not own FL in my portfolio because I believe I can generate long-term growth with limited downside risk in a much more efficient way. This is why I built my Storm-Resistant Growth Portfolio. To learn more about it, click here and take advantage of the 14-day free trial.
