Foot Locker (NYSE: FL) shares recently approached 5-year lows after the footwear and apparel retailer's weak second quarter earnings report missed analyst estimates. Its revenue fell 4.4% annually to $1.7 billion, while comparable-store sales declined 6% and non-GAAP earnings dropped 34% to $0.62 per share -- $0.28 below expectations.
According to Wall Street, Foot Locker revenue will rise 1% this year, as earnings shed 5% on tougher competition and more discounting. However, the stock looks fundamentally cheap at just 8 times forward earnings, compared to the industry average P/E of 21 for footwear retailers. Should contrarian investors take a chance on this struggling stock?
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What happened to Foot Locker?
Foot Locker has had to grapple with slowing mall traffic, competition from other footwear retailers, and major footwear brands selling directly to consumers through online channels.
Nike, for example, already sells through its website and app but recently agreed to open an online shop on Amazon.com earlier this year. Along with Under Armour and Adidas, the industry leaders are also expanding their own brick-and-mortar presence -- which could render middlemen retailers like Foot Locker obsolete. Sports Authority closed up shop last year, and rival Finish Line also trades at a multi-year low.
These headwinds should intensify over the next few quarters. Cowen & Company analyst John Kernan recently called the market shift toward direct-to-consumer channels a "contagion" for Foot Locker, and warned that its comps and margins would continue sliding as it struggles to counter those challenges.
What's the turnaround plan?
During last quarter's conference call, CEO Dick Johnson declared: "The disruption taking place today in our industry, and in retail in general, is the most significant I've seen in my quarter-century in the athletic business." Johnson went on, "The fact is that we're seeing mobile technology drive shifts in consumer behavior and spending patterns at a faster pace than our industry has been able to keep up with."
Going forward, Johnson stated that Foot Locker is working with leading suppliers to shorten the product development, ordering, manufacturing, and marketing cycles but admitted that those efforts were still "in their infancy". He stated that the company was investing more heavily in mobile apps and analytics to better understand customers and the styles they demand. But at the same time, Foot Locker plans to reduce its capital spending from about $277 million this year to $250 million next year -- which might protect margins but reduce its ability to mount a comeback.
Johnson also blamed the footwear makers themselves, claiming that Foot Locker's results "were affected by the limited availability of innovative new products in the market." However, industry watchers should note that Adidas performed very well over the past year with its celebrity-backed "retro" styles, a disruptive trend which Foot Locker's management failed to fully cash in on.
The company might not see Amazon as "an imminent threat" since customers like to feel and try on sneakers in store, but it'll continue shuttering stores this year.
Not a value play yet
Foot Locker's earnings miss was disappointing, but it was management's comments during the earnings call that convinced me the stock isn't a contrarian play yet.
The way management pushed weak results on footwear makers while dismissing competitive threats like Amazon raises red flags, and Johnson's turnaround plan probably won't be enough to overcome shifting consumer tastes, growing direct-to-consumer channels, and slumping sales of athletic footwear in the U.S. -- which fell 5% in July, according to NPD. Foot Locker stock might look cheap, but it could still head much lower if the company continues to underestimate major headwinds.
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