Foot Locker (NYSE:FL) recently reported surprisingly strong second-quarter numbers that were headlined by an 18.6% rise in comparable sales, a 17.3% increase in net sales and a 173% gain in online sales, all in the midst of a pandemic. Yet, despite those strong numbers, FL stock barely moved in the wake of the results.
Source: Roman Tiraspolsky / Shutterstock.com
Clearly, the market is still negative about Foot Locker, partly because of fears that Covid-19 is causing shopping in stores to be depressed. Further, there are fears that apparel makers are selling their products directly to consumers, eliminating the need for retail partners like Foot Locker.
Both of these fears are exaggerated.
And at its current levels, FL stock is just too cheap to ignore.
So buy the shares on weakness, let fears about the company pass, and watch the company’s stock price soar to $40-plus.
Foot Locker’s Strong Earnings
Foot Locker’s Q2 earnings report was surprisingly strong.
After reporting a 42.8% year-over-year drop in comparable sales in Q1, Foot Locker turned its business around, reporting an 18.6% surge in comparable sales in Q2.
Powering the turnaround was a rebound in the company’s physical stores, boosted by the reopenings of more stores and stronger traffic. And the revenue of its digital business soared 173% YOY in Q2.
Impressively, the company was able to deliver those numbers even though only about 70% of its stores were opened. And its sales, general. and administrative spending fell, while its revenue jumped 17.3%.
Its gross margins fell 4.2 percentage points YOY. But the decline was mostly caused by the company’s efforts to unload its inventory. That effort was successful, and its inventories dropped 2.7% YOY.
Overall, then, the struggling retailer reported very impressive, strong results.
Worries About the Impact of Covid-19 on FL Stock Are Overdone
Foot Locker’s shares failed to meaningfully rally in response to the strong results because of two prevailing fears that are depressing investors’ sentiment:
- The Covid-19 pandemic continues to make shopping in physical stores challenging, and Foot Locker makes most of its money in such stores.
- The athletic apparel industry is rapidly streamlining into a direct-to-consumer model, thereby squeezing out retailers like Foot Locker.
Both of these fears are overstated.
The pandemic will probably be over by 2021, when the general public will have broad, easy access to a workable vaccine. Such a vaccine will quickly normalize the behavior of consumers, causing in-store shopping to come roaring back.
In the meantime, retailers are developing innovative strategies to boost their sales and profits, such as moving stores outside and more fully embracing online retail. Clearly, Foot Locker is succeeding in the latter area, as shown by the 18.6% increase in its comparable sales in Q2.
So investors should not let Covid-19 chase them out of FL stock.
Other Fears Are Also Overdone
Meanwhile, although it is true that athletic apparel makers like Nike (NYSE:NKE) and Under Armour (NYSE:UAA) are reducing their sales to retailers and focusing on direct-to-consumer sales, Foot Locker is actually on the right side of this trend.
Third-party distribution is important for the makers of athletic apparel. Just think about all the places that consumers buy the products of Nike and Under Armour, including Foot Locker, Dick’s Sporting Goods (NYSE:DKS), Nordstrom (NYSE:JWN), Finish Line and many more.
Those distribution channels represent a sizable chunk of Nike and Under Armour’s sales. So these brands won’t ditch third-party retailers entirely. They will just lower the amount they sell to retailers going forward and be more selective about the retailers to whom they sell their products.
In other words, the third-party athletic apparel retail distribution pie is shrinking. But those who make the cut will benefit from market-share increases.
Foot Locker is making the cut, as its comparable sales in 2018 rose 2.7%, and its comp sales in 2019 rose 2.2%. If it wasn’t for the pandemic, its comp sales would be positive this year, too. And they still might be positive even with the pandemic.
Clearly, Foot Locker is still able to grow despite the downsizing of the retail category.
More importantly, Foot Locker will continue to make the cut going forward. The company has a differentiated brand, with strong brand equity and high consumer awareness. Its stores are unique, fresh, and in-line with current trends. The company has accumulated strong celebrity endorsements and developed innovative marketing techniques, making Foot Locker stand out.
Thus, going forward, Foot Locker will become an increasingly important player in the more focused athletic-apparel space.
Foot Locker Stock Is Dirt Cheap
Because of the prevailing fears, FL stock is dirt cheap today.
Wall Street analysts, on average, expect the company to earn about $4 per share next year. The FL stock price today is $29. So Foot Locker stock is trading at a very modest 7.2 times next year’s expected earnings.
That’s dirt cheap.
Consumer discretionary stocks typically have a forward P/E multiple of 15 times. Apparel retail stocks typically trade for around 20 times their forward earnings, and footwear stocks normally trade for more than 20 times their forward earnings.
So FL stock is really dirt cheap.
That dirt-cheap valuation would be warranted if Foot Locker would not be able to grow its revenues and profits over the next few years. But that isn’t the case. Foot Locker will leverage its superior branding, strong athletic-apparel demand and rising footwear sales to offset its much smaller challenges. Consequently, it will deliver positive revenue and profit growth over the next several years.
So FL stock will soar. Based on my estimates, I think the stock can climb above $40 and move closer to $50 within the next 12 to 18 months.
The Bottom Line on FL Stock
Foot Locker stock may not look like a winner today, but I think that’s going to change over the next few quarters.
Rebounding consumer spending, more favorable athletic-apparel market dynamics and rising footwear demand, along with Foot Locker’s dirt-cheap valuation, will spark an enormous turnaround in FL stock over the next 12 to 18 months.
Buying its stock ahead of that turnaround is the smart move.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San D ego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long UAA.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.