With a 27.9% washout like we had on Friday – at the tail end of an earnings season with more third-standard deviation stock reactions (90% on the downside) than we’ve seen since the Great Recession -- the questions that have to be answered are 1) is this industry broken? 2) does this concept need to exist? 3) at what sales productivity level? 4) at what steady-state margin? 5) resulting EPS power?, 6) is it in guidance?, and 7) is the stock cheap enough on the REAL number that it could be setting up to be an interesting long. Let’s go…
1) The industry is not bust. It’s in severe transition – but it ain’t broke and it’s not being ‘Amazoned’. Americans don’t buy kicks on Amazon. At least not yet. We buy between 1.2-1.4x pair of kicks per capita per year in the US – about 0.9x per cap in Europe. Is 90% of growth coming from online? Yes…but it’s not Amazon. It’s Brand DTC (margin accretive Retail and Online for the NKE’s Adidas’ and even LULU’s of the world), and Traditional brick&mortar Retail’s e-comm – which is both margin and return dilutive. Are we closer to the 1.2x per cap at a 2-3% lower ASP? For sure. Not good, but not broken.
2) Yes, Foot Locker needs to exist. This is NOT a name that should be lumped into the ‘zero terminal value and will get 100% disintermediated’ basket. This is a decent business with reasonable returns – though a Board with horrible risk management that allowed one single Brand to account for 73% of sales. Even after Nike sells on Amazon – at a higher price point than Nike is telling Foot Locker management – there is still a productivity and margin level where FL has a defendable earnings base.
3) What Sales Productivity level. The overwhelming driver to productivity has been Nike – we all know that. But people likely know the facts more than the math behind them. Nike drove traffic, conversion, and ASP in a steeply declining mall traffic environment. Sales productivity troughed at $375, and peaked at $590/ft. The last $200 per foot in higher productivity had an incremental margin of 30%. Nike was under-penetrated at FL, and now it’s over-penetrated (even with 5-point decline over 18 months). We think the ‘new normal’ is Nike penetration of 50-55%. That equates to sales productivity of about $525 per ft (ie down about $60 from here).
4) Steady State Margin. FL meaningfully under-invested (capex and SG&A) in a manner to sustain a low-teens EBIT margin. The higher productivity was driven by Nike, and FL let far too much flow to the bottom line. I don’t think FL management did anything wrong – but simply invested enough (or not enough) for this to be a 7-8% margin business all along. It just didn’t know it. The extra $200/ft in productivity was a gift. In the end, with steady-state GM of 31.8%, and 25.1% SG&A ratio, we get to margins of 6.7% over a TAIL duration.
5) TAIL EPS power. $525 productivity (incl DTC up to 18% from 13% last year), 31.8% GM margin, 25.1% SG&A (incl D&A) + financial deleverage and all that = $2.40 in earnings. Yep.
6) Not in guidance. This year is a roller-coaster TRADE/TREND.
- Next quarter looks high by 10-15%. But FL guided annual EPS to decline 20-30% in the 2H. That’s 15% too low – and does not give credit for an extra week
- Next year the Street is sitting at $4.58 per share. Maybe that will still come down as sell-side estimates hit over the next day or two. But our ‘steady state’ EPS is $2.40. Even if the Street’s numbers come down by an extra buck…it’s arguably still a buck too high.
7) Valuation support…
- Support will probably come at the Street number – which people will think is washed out even though it’s not. So on consensus of $4.58, a $34.38 stock is 7.5X P/E, 3.4X in EBITDA, and a 10% FCF Yield. That’s downright cheap – like, seriously.
- On our numbers we’re looking at 14.3X P/E, 5.5X in EBITDA, and a 7% FCF Yield. That’s a much different story – especially one that will arguably not grow anymore.
- From where I sit, I’d look through the ‘cheap’ multiple as it relates to stepping up and buying this today. There’ll be TRADE opportunities around the quarters. But I don’t get interested long-side until this is a $22-$24 stock. That means it's still a short.
FL | Sandbags Mattering Less: LINK
