Investors are tossing shares of Foot Locker (FL -4.11%) onto the clearance rack. Shares of Foot Locker have fallen sharply based on a disappointing outlook on its earnings call (the company expects sales to fall by 4% to 6% in 2022) , growing concerns that Nike's direct-to-consumer (DTC) business is cutting out the middleman, and a slew of analyst downgrades and are now down more than 50% from their 52-week high.
Why the pain?
On its latest earnings call, Foot Locker revealed that it will be diversifying its product mix so that no one vendor will make up more than 55% of its supplier spending . Historically, Nike has made up an overwhelming percentage of Foot Locker's inventory, which has been good for Foot Locker since Nike has incredible brand strength and has been in demand for years. For example, in 2020 Nike made up about 75% of Foot Locker's inventory.
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Judging from the downgrades and price drop after the call, it seems that analysts and investors alike don't like this move. There is also concern that Nike's growing online, direct-to-consumer business will diminish Foot Locker's role as a partner for Nike.
However, 55% is still a relatively large amount of purchasing to devote to one vendor, so it's not like Nike is going away. Nike has cut off many vendors altogether over the last few years, ranging from Zappos to Urban Outfitters, and even pulled its sneakers from Amazon.
But Nike stuck with Foot Locker, indicating that the company still sees some value in it as a partner. Furthermore, it doesn't seem like a bad idea to diversify and not be as overly reliant on one vendor. It can be an opportunity for Foot Locker to increase its business with other brands. Non-Nike sales increased 30% during the quarter, and sales of apparel and accessories also increased by 30%.
On the call, Foot Locker's CEO pointed toward growing sales with companies like adidas, Puma, and even Crocs, perhaps showing the path forward, so perhaps the path forward is starting to come to fruition.
Big-time returns to shareholders
Foot Locker is ramping up its return to shareholders. The company raised its dividend by 33% to $0.40 a share, giving it a forward yield of over 5%. This is a compelling payout for income investors and a yield on the level typically only seen in the telecom or utility space. It is an old investing adage that the safest dividend is the one that was just raised.
In addition to the dividend raise, Foot Locker's board of directors also authorized a new share repurchase program that will allow the company to buy back up to $1.2 billion of shares. Foot Locker's market capitalization is just $4.2 billion, so this would be an incredible 28% of the company's shares outstanding.
Share buybacks are another way of returning capital to shareholders, as they reduce the company's share count and increase earnings per share. Even better, reducing the number of shares increases the proportion of the company you own as a shareholder and makes the remaining shares worth more. Furthermore, they can be a signal that management feels shares are undervalued.
Bargain-bin valuation
After the recent sell-off, Foot Locker looks ridiculously cheap on almost every valuation metric. Foot Locker now trades at a price-to-earnings multiple of just over 3, which is incredibly inexpensive and a steep discount to the S&P 500 as a whole. Foot Locker even looks cheap on this basis when compared to peers in the retail space like Kohl's or Dick's Sporting Goods, which both trade at price-to-earnings multiples of over 8. Shares also trade at a price-to-sales ratio of less than 0.5 times sales.
Foot Locker is also priced at less than its book value of $32 per share. Book value is essentially the value of the company if it was liquidated, so Foot Locker is being valued even below that low bar.
The company also has $9 of cash per share on its balance sheet and very little long-term debt, further adding to the value proposition here.
Is Foot Locker a buy?
While the company will indeed have to navigate through diversifying its product and vendor mix, and the results from the conference call were disappointing, shares are now very cheap for what still looks like a healthy, stable business. Between this valuation, the increased dividend payout, and the massive share repurchase program, I'm willing to call Foot Locker a buy here, hold it, and enjoy the returns to shareholders while the company iterates on its strategy and charts the best way forward.
