Upping FL on our Best Idea Long List to #2, behind BYON. Second time in the last week we’ve upped names ahead of RH – previously our #1 Long for years. But gotta stay fluid...and the reality is that over a six month time frame, we'd rather own FL given the set up. Oh the irony that we're putting one of the worst companies in retail ahead of one of the best. We've been long FL since $16.50 in August, so we're still ahead on the trade – though we got tagged big time today. Way oversold given the catalyst calendar and upward revision cycle we're about to see.
4Q looks bad in absolute, fine vs expectations, and good from a rate of change perspective. The stock is reacting negatively to guidance. For 2024, we think management is being wise on the earnings side. Recall last year was a guidance train wreck, the company lowered the year, had to guide down big on 1Q print, then had to guide down big on 2Q print… punchline management needs to put out a number it can beat. The only part we’d view as truly net bearish is the cash flow cadence, as the company is stepping up capex, meaning even with operational improvement FCF probably doesn’t get better. That could be spooking the value investors today. The company also revised its long term margin cadence outlined last spring pushing the 8.5% to 9% 2026 target to 2028. This is arguably prudent expectations by management given the street was already down to 5% for 2026, and 2023 went far differently than it initially expected. If margins here are going to 9% by 2028 this stock is still a homerun.
The company is deploying capital towards its growth opportunities in the core Foot Locker banner and Foot Locker Kids where we think there is share and profitability improvement potential. Its pulling capital away from losing banners like Champs, where the company net closed 82 of 486 stores, and where we think the company will be gradually phasing out the money losing banner. Gross margins were guided ahead for 2024 with reduced markdowns as it comes into the year with much cleaner inventories (down 8% YY this Q vs +11% last Q), some of that upside is being reinvested into SG&A, which we like to see as it relates to growth potential, but also perhaps gives some wiggle room to ensure beating numbers in 2024. The rate of change setup looks very bullish here with easy compares on revenue and gross margin and the company outlining a return to growth with Nike coming later in the year, which has been a pillar of our bull case. When Nike starts flowing allocations back to FL, comps and margins will ramp fast. We could easily see 5 quarters of accelerating growth and margin trends with low (i.e. beatable) absolute expectations. That’s the kind of fundamental setup we want to own.
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