Foot Locker Doesn't Exactly Bomb, but It Does Disappoint

Shares of shoe retailer Foot Locker (FL -0.69%) took a bath following its second quarter 2019 results. The company looked to have cracked the code for brick-and-mortar store success, but it reported negative foot traffic at its stores in all geographies -- here in the states and abroad.

Yet it wasn't all bad. Management said business picked up as spring gave way to summer, and foreign currency exchange rates were the primary reason revenue went backward instead of forward. With the top team at the shoe chain reiterating its positive guidance for the year, this looks like a pretty cheap dividend stock.

A tale of two quarters

Sporting goods and apparel stores have been under assault. According to data from the U.S. Census Bureau, both categories have struggled the past few years under the weight of online-only retailers -- not to mention online direct-to-consumer efforts from the likes of Nike, Adidas, and Under Armour. Through the end of July, sporting goods and apparel store sales are down 5.2% and 0.5%, respectively, even as overall consumer spending continues to rise over 3% year over year.

Image source: Getty Images.

But Foot Locker has been a standout. After reporting a 2.7% increase in comparable-store sales (a combination of foot traffic and average customer ticket), first-quarter 2019 comps grew 4.6%. Management issued forecasts that included mid-single-digit comps growth for the full-year period. That's great news, given the so-called "retail apocalypse" going on out there.

It was therefore a surprise that second-quarter comps came in at a mere 0.8% increase, with declining foot traffic offset by higher merchandise pricing. As with the first-quarter results, poor foreign currency exchange rates -- converting overseas sales back into dollars -- also took a hefty bite out of revenue and caused a 0.4% decline versus a year ago. Excluding exchange rates, revenue would have grown 0.8% because of the slight increase in comps.  

Thus, what was shaping up to be a rock-solid year is now in doubt. Paired with the U.S.-China trade war escalation, which could raise prices on shoes and apparel manufactured across the Pacific and dampen consumer spending here, the first half of 2019 isn't looking quite so rosy anymore.

Data source: Foot Locker. YOY = year over year.  

What comes next?

Here's the upshot, though. Even with things seemingly coming off the rails in the second quarter and a subsequent increase in risk from U.S. tariffs on goods of Chinese origin, Foot Locker maintained its outlook for positive mid-single-digit comparable sales this year, as well as a high-single-digit increase in earnings per share, thanks to the company's share repurchase activity. How's that possible? Well, the top team at Foot Locker said comps steadily improved throughout the quarter; the metric was in low-single-digit negative territory in May, positive low single digits in June, and the targeted mid-single-digit range in July.  

Though the shoe chain is up against direct-to-consumer competition from its athletic apparel suppliers, its own digital selling model is a bright spot, too. Second-quarter e-commerce was up 6.5% from a year ago, bringing the percentage of sales from online sources to 14.3% of the total -- proof that a rising tide really does lift all boats, or most of them, anyway. 

Thus, I'm staying the course with my small handful of shares in Foot Locker, with an eye to picking up a few more soon. The stock trades for a mere 7.5 times the past year's worth of free cash flow -- basic profits after cash operating expenses and capital expenditures are paid for -- and the dividend is currently yielding 3.6%. Not bad for a retail stock.

Of course, I would be remiss to neglect saying that, though the cheap valuation and dividend offer some margin of safety, shares could tank further if Foot Locker's business fails to sustain some sort of rebound -- or, worse, geopolitical issues sour profit margins. My point is that investors should tread lightly following the second-quarter report card.