Foot Locker (FL 0.23%) stock is getting cheap enough to show up on many value investors' radars. The retailer's shares are down by over 50% this year and are sitting at a 10-year low. You couldn't buy Foot Locker at this price even during the worst of the pandemic stock market crash.
The 2023 slump is being driven partly by industry conditions that won't last forever. Too much footwear supply, combined with more cautious consumer spending patterns, is forcing retailers to cut prices so inventory can keep moving. These factors are impacting many players, including Nike and Crocs.
But Foot Locker has some unique challenges that make it a far less attractive investment than its industry peers. Let's take a look at three specific issues.
1. Things will get worse
As bad as the company's recent earnings report was, it's highly likely that results will worsen heading into early 2024. Foot Locker said in late August that comparable-store sales declined 9%, which was close to management's reduced expectations.
But customer traffic trends weakened in last few weeks of the period, convincing Foot Locker to reduce its 2023 outlook for a second straight quarter. Sales are now projected to drop by between 8% and 9% compared to the prior range of declines between 7% and 8%.
Worse yet, Foot Locker is being forced to slash prices on many of its products so that consumers keep buying its footwear. Management blamed the need for "more aggressive markdowns" when it lowered its profit margin outlook for 2023. Net loss was $5 million in Q2 compared to a profit of $94 million a year earlier.
2. Weakening balance sheet
Foot Locker is in a precarious financial position, too. It burned through $184 million of cash in the first half of 2023. Cash on the books as of late July was just $180 million compared to $450 million of debt.
FL Free Cash Flow data by YCharts
It's no surprise, then, that management pulled back on stock repurchases. But Foot Locker also took the extraordinary move of suspending the dividend, which most recently resulted in a $37 million cash return to shareholders. The pause should help Foot Locker's finances, but it also reflects the serious pressure on the business right now.
3. Shrinking store base
Finally, Foot Locker's sales base is shrinking. The company opened just 15 new locations this past quarter while closing over 100 of its stores. Its global footprint is now less than 2,600 stores, down from 3,100 at the start of 2020.
The good news is that most of these closings are focused on Foot Locker's weakest locations. That means profitability will get a lift from the removal of these stores and from the reduced maintenance and real estate expenses. But it will get harder to generate sustainably rising annual earnings without an expanding sales base. Shareholders are likely to see a prolonged period, in other words, of weak profits from this retailer.
Yes, Foot Locker shares are priced at a big discount today. But that's also true of other, more successful industry peers. You can own Crocs, which is growing sales and boosting margins, for 1.4 times revenue, down from over 2 just a few months ago. Similarly, Nike's valuation in 2023 has declined from 4 times sales to just 2.8.
These two footwear specialists are profitable and growing, and they don't face large inventory challenges like Foot Locker does. Investors should consider them as far more attractive ways to gain exposure to this retailing industry.
