Why Foot Locker Is The Retailer Every Dividend Investor Should Buy

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About: Foot Locker, Inc. (FL)
by: Robert & Sam Kovacs
Summary

Foot Locker needs to find a path back to revenue and earnings growth.

In the meantime, it has fantastic fundamentals and can afford multiple 10% dividend hikes in upcoming years.

The stock has a fantastic buyback program which alone should add 6-7% to the share price each year.

If the company has a positive earnings surprise, the stock price could appreciate another 20-30%.

Note: To learn more about the Machine Assisted Dividends (M.A.D.) methodology, you can read this post, which my father Robert Kovacs published. All financial data from my company mad-dividends.com is sourced directly from the SEC, whereas pricing data comes from IEX.

Written By Sam Kovacs

Introduction

Foot Locker (FL) has a dividend yield of 2.64% and is trading at $57.63 per share. According to my M.A.D. assessment, FL has a dividend strength score of 82 and a stock strength score of 100.

I believe that dividend investors should invest in Foot Locker at current prices. It is exactly the type of stock we are looking for as dividend investors.

Source: mad-dividends.com

Foot Locker Inc. operates in the footwear industry. Its core business involves retailing of athletic shoes and apparel through mall-based stores.

M.A.D. assessments are presented in two sections: dividend strength and stock strength

I look at stock and dividend strength as 2 distinct subjects. A high dividend strength score indicates that the company has a good combination of dividend safety, dividend yield, and dividend growth potential. Whereas a high stock strength score is an indicator that the share price is likely to increase in upcoming quarters. Dividend investors can expect to do well by investing in stocks which rank highly in both dividend strength and stock strength.

Dividend Strength

Dividend strength can be broken down into a) dividend safety and b) dividend potential.

Therefore, we can break down dividend strength into two dynamics: dividend safety and dividend potential

I will look at FL's payout and coverage ratios to assess dividend safety. The company's dividend potential is measured by looking at the current dividend yield, the dividend's historical growth as well as the changes in the revenues and net income over the recent years.

Dividend Safety

30% of Foot Locker Inc.'s earnings are paid out as dividends. This is a more attractive payout ratio than 63% of dividend stocks.

Operating cash flow payout also gives a good idea of a company's ability to pay its dividend and gives a more complete picture than simply looking at the earnings payout. FL pays 21% of its operating cash flow as a dividend, putting it ahead of 62% of dividend stocks.

To finish my assessment of FL's payout ratios, I turn to free cash flow payout, which gives an idea of the company's ability to pay its dividend after paying for its Capex. Foot Locker has a free cash flow payout ratio of 28%, a better ratio than 70% of dividend stocks.

Foot Locker Inc.'s payout ratio is extremely satisfying according to these 3 metrics. The company generates loads of cash flow, plenty enough to pay for the dividends, and has very low levels of capital expenditure.

31/01/2015

30/01/2016

28/01/2017

03/02/2018

02/02/2019

Dividends

$0.8800

$1.0000

$1.1200

$1.2400

$1.4000

Net Income

$3.56

$3.84

$4.91

$2.22

$4.66

Payout Ratio

25%

27%

23%

56%

31%

Cash From Operations

$4.87

$5.29

$6.03

$6.35

$6.72

Payout Ratio

15%

16%

16%

18%

21%

Free Cash Flow

$3.54

$3.64

$4.05

$4.19

$5.03

Payout Ratio

25%

28%

28%

30%

28%

Source: mad-dividends.com

Analyzing interest and debt coverage ratios along payout ratios gives us an idea of the payout ratio's stability. If a lot of the company's earnings go towards paying interest, the financial leverage makes the company's bottom line more affected by variations in revenue.

FL can pay its interest 80 times, which is better than 95% of stocks. This level of coverage can be considered very satisfying.

Looking at payout and coverage ratios together would suggest that FL’s dividend is very safe.

Not only does the company generate loads of earnings and cash flow, it does so on very little leverage. Interest represents only a fraction of the company’s earnings. No doubt, FL can safely continue to pay its dividend and has room to grow it.

Dividend Potential

I then move on to analyzing the company's dividend potential (i.e.: its ability to pay us a good dividend, which grows at a satisfying rate).

Source: mad-dividends.com

Foot Locker Inc.'s dividend yield of 2.64% is better than 57% of dividend stocks. While the stock has historically offered higher yields, it has also been priced a lot higher in relation to the dividend. 2.64% is an average yield and will need to be backed up with 10%+ dividend growth.

Which is convenient because, this year, FL grew the dividend by 10%, which is slightly lower than their 5-year CAGR of 12%. This level of growth can testify management’s commitment to returning cash to shareholders as the business grows.

Source: mad-dividends.com

Over the previous 3 years, Foot Locker has seen its revenues grow at a 2% CAGR, while net income has remained flat. It is important for a company to continue growing revenues and net income in order to continue paying and importantly for a dividend investor growing its dividends.

Source: mad-dividends.com

If the company can continue to grow its revenue and net income at the current rate, FL’s dividend has good potential for growth.

While the company is maturing and will need to find a path to higher top and bottom line growth, its cash flow and earnings are already high enough to warrant multiple 10% dividend hikes in upcoming years.

It is worth noting that the company’s success is closely tied to how well Nike (NKE) fares. 66% of all 2018 sales in Foot Locker stores came from Nike products.

Source: mad-dividends.com

As long as Nike continues to be successful, FL will likely remain a retailer of choice because of its iconic status in sneaker culture. However, FL still needs to find a way to expand its sales in upcoming years.

Revenues from the company's online earnings (direct to consumer) have increased at a fast rate: 10.45% growth in 2018, 8.25% in 2017. On the other hand, revenue from stores has remained flat.

Direct to consumer sales represent only 15.4% of total sales, which suggests that the company still has room to improve and grow the segment while maintaining its stronghold in retail locations.

Source: mad-dividends.com (original SEC filing here)

Dividend Summary

The combination of the data presented above gives FL a dividend strength score of 82/100.

FL has great dividend potential, the only negative point being the lack of growth in revenues and net income. However, future dividend growth can come from the existing stream of free cash flow. As we'll see later, FL doesn't need to strengthen its balance sheet and can afford to grow the amount of free cash flow it returns to shareholders.

Assuming the current free cash flow levels, FL could increase the dividend by 10% for 15 straight years before it dedicates all FCF to a dividend.

As such, I’m confident FL will continue to increase its dividend for the next 3-5 years. We will still want to monitor whether the company can increase revenues in upcoming years.

Stock Strength

When picking on dividend stocks, investors must focus on more factors than dividends alone. To pick the most attractive dividend investments at any given point in time, we must also focus on other factors.

Within the company's stock strength score, we look at four factors: value, momentum, financial strength, and earnings quality.

Each of these factors will be analyzed, one by one, to best understand the stock's underlying dynamics.

Value

It has been proven time and time again that undervalued stocks outperform overvalued stocks. To assess value, I look at a company's P/E, P/S, P/CFO, and Shareholder Yield. The combination of these ratios gives a stock a value score out of 100.

  • FL has a P/E of 19.67x
  • P/S of 0.84x
  • P/CFO of 8.97x
  • Dividend yield of 2.64%
  • Buyback yield of 9.23%
  • Shareholder yield of 11.89%.

These values would suggest that FL is more undervalued than 91% of stocks, which is extremely satisfying. This is where only screening stocks based on earnings comes up short.

You wouldn’t think much of FL’s value if all you see is a 2.6% dividend yield and 19.7x PE. But, when you look beyond, you realize that the company is trading below 1x sales, below 9x cash flow and has a mind-blowing buyback yield of 9%.

Another 18% of FL shares (assuming current prices) will be bought back between now and January 2022. That’s an annualized 6.5% buyback yield between now and then.

Companies which have high shareholder yields and return loads of cash to their investors through buybacks, as well as dividends, usually do great.

Value Score: 91/100

I also draw PE lines over a stock chart, very much like Peter Lynch would do while running the Magellan Fund. By doing so, investors get an idea of the company's PE range, and it serves as an indicator of potential downside and upside.

Source: mad-dividends.com

The chart above suggests that FL is trading around its 5-year average PE. As we can see, FL has been somewhat range-bound these past few years, and an increase in earnings will be required for the investment community to re-rate FL.

Momentum

Buying losing stocks is never a good idea, even if your main motivation is to receive a dividend.

Foot Locker Inc.'s price has increased 2.02% these last 3 months, 14.71% these last 6 months, and 37.67% these last 12 months, and now, currently, sits at $57.63.

Source: mad-dividends.com

FL has had a great year, but now seems range-bound. While an earnings surprise could see the stock's momentum shoot up, the stock should continue to fare quite well regardless throughout 2019.

FL has better momentum than 79% of stocks, which I find to be satisfying.

Momentum score: 79/100

Financial Strength

Stocks with good financial strength will have reasonable levels of debt, low liability growth - or even decreasing liabilities - and will produce high levels of cash flows in relation to their liabilities.

Financially strong stocks have historically performed a lot better than companies with weak financials. It goes without saying that investors should be extra careful with stocks who dramatically increase their financial leverage.

FL's Debt/Equity ratio of 0.5 is better than 79% of stocks. Foot Locker Inc.'s liabilities have decreased by 9% this last year. Operating cash flow can cover 59.4% of FL's liabilities.

These ratios would suggest that Foot Locker has better financial strength than 97% of stocks. The extremely low leverage, decrease in liabilities, and expansive amounts of cash flow make FL one of the best in class when it comes to financial strength.

Financial Strength Score: 97/100

Earnings Quality

Stocks with high earnings quality will have low levels of accruals and will depreciate their capital expenses quickly. Their assets will also generate large amounts of revenue.

Foot Locker Inc.’s Total Accruals to Assets ratio of -13.5% puts it ahead of 66% of stocks.

95.2% of FL's capital expenditure is depreciated each year, which is better than 41% of stocks.

Each dollar of FL's assets generates $2.1 of revenue, putting it ahead of 95% of stocks.

Based on these findings, FL has higher earnings quality than 86% of stocks.

FL generates high amounts of revenue relative to its asset base. It also has a comfortable amount of negative accruals, which will be accretive to earnings in upcoming years.

Earnings Quality Score: 86/100

Stock Strength summary

When combining the different factors of the stock's profile, we get a stock strength score of 100/100, which is fantastic. When looking at all four factors in combination, it is hard to find a stock which looks as good as Foot Locker does. It ticks all the boxes from fundamentals to valuation and momentum.

Conclusion

With a dividend strength score of 82 and a stock strength of 100, Foot Locker is a great choice for dividend investors.

Because of the company’s fantastic fundamentals, it can afford some time to go back to higher revenues growth. In the meantime, the price should appreciate at a comfortable rate thanks to an expansive buyback program and a dividend which appreciates at a high rate.

I can only advise dividend investors to buy FL. However, we will want to monitor it in upcoming years, with a close focus on revenues and earnings.

Over the next week, we’ll analyze another 6 apparel companies. While FL deserves a place in your dividend portfolio, other stocks deserve to get the boot. Follow us if you liked this article and want to be notified when the next one comes out.

Disclosure: I am/we are long FL. 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.