The Company
Foot Locker (FL) is a footwear retailer. Co.'s portfolio of brands include: Foot Locker, a youth culture brand that connects consumer with sneakers and apparel including brands such as Nike, Jordan, Adidas, and Puma, as well as brands in the athletic and lifestyle space.; Kids Foot Locker, which provides a selection of athletic footwear, apparel, and accessories for children; Lady Foot Locker, a retailer of athletic footwear, apparel, and accessories dedicated to young women; Champs Sports, an athletic footwear and apparel retailers in North America; and Footaction, a North American athletic footwear and apparel retailer that provides a selection of athletic lifestyle brands and looks.
The stock is up 6% this year which is almost the same as the S&P 500, but from January 2020 to December 2020 the stock had a total return (dividend reinvested) of 9.59% while the S&P 500 had a total return of 17.28%.
Revenue growth has been very slow in the past couple of years especially last year, footlocker finished the year with $8 billion in revenue with just a 1% increase from 2019’s $7.9 Billion. the pandemic has hit brick and mortar stores the hardest. Back in March 2020, the company closed stores around the world because many of foot locker’s stores are located in enclosed regional and neighborhood malls. The stores account for more than 83% of the company’s total sales.
While the sneaker market is valued at around $76 Billion, The global apparel and footwear retail sales are set to reach $3 Trillion by 2030 which means there is a lot of opportunity for retailers in the space especially footlocker.
The Sneaker Culture
Sneakers were primarily made for the basketball court but have left the court a long time ago and are now worn by anyone with (or without) a sense of fashion (even the casualization of the workplace stylish sneakers are now acceptable in most offices), stylish sneakers are now becoming part of an everyday fit for most people.
For the most part, the sneaker industry is all about hype, although the retail industry is well known for having thin margins, whenever there is a hot new sneaker that is driven by “hype” the bottom line in the income statements takes care of itself. Customers wait in long lines for hours just to get a pair of their favorite shoes.
Who creates the hype? In the sneaker industry, It’s normal for brands to work with celebrities, influencers, and other brands to come up with new designs for shoes. When your favorite artist collabs with your favorite line of shoe and you just herd there will only be a limited amount of pars made….it’s the perfect formula to create the hype!. A good example would be the Kanye West and Adidas (OTCQX:ADDYY) Yeezy.
Who buys the hype? Just like watches and cars, there are a unique set of individuals who are also willing to pay a premium for their obsessions, sneakerheads and hypebeast are probably the two biggest spenders in the sneaker industry
Hypebeasts generally refers to a person who is devoted to acquiring fashionable items, they follow trends in fashion, particularly streetwear, sometimes to make a social statement. they are willing to pay a premium to get the latest most fashionable item in the market.
While sneakerheads are shoe enthusiasts, a sneakerhead is someone who collects, trades, and or admires sneakers as a hobby. Generally, sneakerheads are well-versed in the history of sneakers.
Some sneakerheads prefer to collect only while others resell but there also others that do both (some even buy two pairs, one to add to their collection and the other for reselling). According to Cowen (COWN), the resell market could reach $30 Billion by 2030. The firm has even viewed sneakers as becoming an alternative asset class for investors and believe that they provide diversification as they are non-correlated with traditional asset classes and earn favorable risk-reward characteristics.
As a sneakerhead myself, I can vouch for a fact that the sneaker culture is not an ephemeral trend, as customers are willing to pay $500 for a pair of Air Jordan 1s (which is my favorite line) or even upward of $10,000 for a limited pair. Smart brands may be wise to capitalize on sneaker culture as the industry is poised to grow exponentially in the next decade.
Nike
Speaking of brands, Nike (NKE) is well known across the world, the company is always up to date not only with the latest fashion trends but are also one of few companies to incorporate the latest tech in footwear, the demand for Nike shoes especially Jordans continue to rise thus making them a valuable partner to footlocker. Jordans have become more than just shoes, they're now a status global symbol and emblem of sneaker culture which has triggered luxury fashion houses like Balenciaga and Louis Vuitton (OTCPK:LVMUY) who have also started releasing high-end sneakers in recent years, and new boutique brands are cropping up all the time.
71% of all merchandise purchased in 2019 was purchased from Nike. Jordans and other Nike products make about 2/3 (65%) of footlocker’s sales.
The deep relationship between the two companies is crucial for both of them, In 2019 Nike parted ways with Amazon inc (AMZN) as the company is trying to focus on elevating the consumer experience. Even though they are strengthening their DTC, with footlocker Nike can continue to grow their relationship with customers through the 3,000+ footlocker stores around the globe!. For example, back in 2019 October, footlocker opened the first and only of its kind a “Nike community power store” which seek to enhance customer experience in Washington heights.
Source: Footlocker inc
This shows the trust and confidence that Nike has in one of its biggest retailers as they both have the same goal and that is to improve the customer experience.
Comps
Foot locker’s competitors Include athletic footwear specialty stores, sporting goods stores, department stores, traditional shoe stores, mass merchandisers, and online retailers.
Source: Author’s own excel model
Based on the comps, the industry proves that it’s brutal when it comes to margins, footlocker’s gross margin is in the low end of the industry with 31% while the industry average is at 43% but they have a much higher operating margin of almost 9% which is higher than the average which is 8% while their net margin is equal to the industry at 6%.
The company has a higher ROA of 9.4% compared to the industry average at 8.7% but has a much lower ROIC and ROE than the industry (they still have an attractive double-digit return). The most impressive metric compared to competitors is the shareholder yield which way higher than the industry average, footlocker has a 9.6% yield which is second to Wolverine World Wide Inc (WWW) who has returned the most to shareholders 13.5%.
Footlocker has always had a sufficient amount of cash which has allowed them to compensate their shareholders YoY. They have a 10-year shareholder yield average of 6.4%. they have returned the most to their shareholders across the industry alongside Nordstrom Inc (JWN) who have an average of 8.8%.
Source: Author’s own excel model
Because of the industry’s highly competitive nature, Companies may attempt to gain an advantage by offering better credit terms which may cause to overstate revenues. footlocker has consistently shown a lower ratio than the whole industry, the only other company to have a low ratio is Hibbett Sports Inc (HIBB). Companies that have an efficient cash collection system are usually in a better position financially with Footlocker being one of them, especially when the general economic condition worsens (like the current pandemic) it creates a high chance of default risk on the credit issued.
Source: Author’s own excel model
The demand for sneakers can be backed up by the numbers, the company has increased its turnover ratio in the last decade from 3.6x to 4.4x, which is the highest across the industry alongside Nordstrom inc. Both companies have sold and replaced inventory more than the rest of the industry over the years
Source: Author’s own excel model
The story is not so different when we come to the day sales of inventory (DSI) or the average age of inventory, Both foot locker and Nordstrom have the lowest DSI, But footlocker has consistently reduced the time it takes to clear off inventory, back in 2010 they had DSI of 110 and in 2020 they reduced it to 81, Which indicates greater efficiency in sales because of the shorter duration to clear off the inventory. Inversely the rest of the industry has seen their DSI increase.
Source: Author’s own excel model
(note: Just to get a better gauge, although amazon inc (AMZN) is also considered a competitor, I’ve chosen to exclude them in the Inventory turnover and DSI metrics because they sell more than just shoes and clothing, they have a much larger stock of goods)
Implied price per share:
Footlocker does seem to have better numbers from a business standpoint, But is their stock price more attractive than its peers?
Footlocker has a much lower P/E ratio than the rest of the industry, Based on analysts estimates, the industry average 2021E P/E is 43.4x while footlocker has a multiple 10.6x, but they also have a lower EV/Revenue and EV/EBITDA with a multiple of 0.9x and 8x respectively while the industry average 2021E EV/revenue is 2.3x and EV/EBITDA is 17x.
Which puts the company’s implied price per share at $158.63! As of January 15 th, FL stock price closed at $47.85
Source: Author’s own excel model
Although the stock is trading way below the implied price, it doesn’t mean that FL is significantly undervalued but rather it’s a bargain for investors who are looking to add a stock that’s in the retail industry to their portfolio.
Valuation
As the sneaker culture grows not just in the U.S but all around the world, this will be a great opportunity for footlocker to open up more stores in other regions and increase their customer reach.
In the next 2 years, I'm expecting the company’s top line to take a hit due to the pandemic, despite strengthening their e-commerce platform, 83% of their sales come from the stores so it’s sensible to see how the pandemic has/will affect their topline.
Although Footlocker can increase its customer reach by opening more stores around the world and strengthen their DTC, they are still a mature company.
So when things go back to normal, revenue should pick back up and grow at a (conservative) growth rate of around 1-2% with a sales to capital ratio of 0.20 which will gradually increase to 1.80 which is slightly below the industry average of 2.20 as the total amount reinvested (from year 1 to year 10) will be around $1.4 Billion based of the estimated sales to capital ratio. the low investment will result in a lower ROIC which will go from its current levels of around 18% to 13%. By the end of the decade, they can expect to have revenues close to $9 Billion.
The growing sneaker culture will prompt manufacturers and retailers to increase the average selling price which will, in turn, increase the companies operating margins from 8% to at least 10%.
The company should have a much lower growth rate in the terminal year of around 0.90% (which was the 10-year treasury rate by the end of last year). With a terminal cost of capital of 5.42% which is the average for the retail specialty industry.
Based on the assumptions, Foot Locker’s intrinsic value is $73.79 with an enterprise value of $9.9 Billion. As of January 15 th, FL stock price closed at $47.85 which makes it undervalued by more than 50%.
Source: Author’s own excel model
For a mature company with conservative estimates in a very competitive industry, the valuation may seem too optimistic but the company has traded around the $75 mark before and they are one of the few specialty retailers that have a well-known brand.
Even though the dividend discount model is best suited for companies with predictable future dividend payment (like dividend aristocrats), just to get a view of where foot locker value ranges from I also used the dividend discount model to estimate the present value of future dividend payments.
Footlocker has been paying dividends for more than 20 years. By end of 2020 they had a 33% payout ratio and a dividend yield of 3%, the company cut their dividend by almost 50% back in October 2020 but their 10-year dividend CAGR is 4.48%.
Footlockers EPS has on average grown by 25% in the last decade, I’m expecting their EPS to grow moderately and at least grow by 1% by 2030 while their payout ratio will also increase from 33% to 60%.
Footlocker price per share came at $69.04 which is not too far off from $73.79, it’s undervalued by more than 40%.
Investment Risk
There is one huge risk that investors need to be aware of and that is footlocker business model is dependent on their relationship with their suppliers.
Footlocker purchases approximately 91 percent of their merchandise from their top five suppliers. The perks include the ability to purchase brand-name merchandise at competitive prices.
Footlocker also states that they negotiate volume discounts, cooperative advertising, and markdown allowances with their suppliers, as well as the ability to cancel orders and return excess or unneeded merchandise. These benefits can be a blessing and a curse at the same time, especially if you consider their biggest supplier Nike.
Several unpredictable events may cause their relationship to slump example, If Nike decides to fully take the DTC route and cut ties with any retailer or any contractual contention between the two companies my take a huge hit on the company’s top line
But so far there are no signs of any fallout between the two, as mentioned before, both parties continue to work together to improve the customer experience.
Foot locker’s e-commerce platform and 3000+ stores continue to build and grow their customer base of sneakerheads and hypebeast from across the world which makes them a reliable retailer for not just Nike but other notable brands like Adidas AG (OTCQX:ADDYY) and Puma SE (OTCPK:PUMSY)
Good business at a cheap price
To conclude, In my opinion, Foot Locker is a good business that is trading at a cheap price. Their 46 years of experience brings tremendous value to the table. They’ve been able to retain and grow revenue and profits year in year out in a competitive industry with thin margins, their strong financial position allows them to consistently return cash back to shareholders, the stock is worth anywhere between $65-$75 per share and most importantly, over the years they have improved the customer experience and ameliorate relationship with suppliers.
(Full Model:FL_Valuation_Model.xlsx)