Footwear retailer Foot Locker (FL -1.27%) is having all sorts of trouble coping with the current economic environment. Sales plunged 11.4% year over year in the first quarter, with comparable store sales down 9.1%. Adjusted profits crashed by more than 50%, free cash flow fell deep into negative territory, and inventories rose dramatically.
The company declared its standard quarterly dividend of $0.40 per share, but investors shouldn't expect that payout to stick. Dwindling cash reserves and plunging profits will make it difficult for the company to continue returning cash to shareholders.
The economy finally takes its toll
Foot Locker was already expecting 2023 to be a rough year, but its performance in the first quarter prompted it to slash its guidance. Previously, Foot Locker expected a comparable sales decline between 3.5% and 5.5%. Now, it sees a decline of between 7.5% and 9%.
Gross margin is set to plunge as Foot Locker faces elevated shrink and gets aggressive with markdowns to clear out excess inventory. The company expects a gross margin of between 28.6% and 28.8% this year, down from 31.9% last year.
Those markdowns will be necessary since Foot Locker is sitting on way too much inventory. The value of the company's inventory jumped 25% over the past year, consuming cash that will be increasingly needed as sales plunge. Foot Locker had $313 million in cash and cash equivalents at the end of the first quarter, down $223 million from the beginning of the year.
Free cash flow was a loss of $177 million in the first quarter. The buildup of inventories accounted for a big portion of that loss, but even if inventories hadn't grown at all, free cash flow would still have been in negative territory.
Harder to justify the dividend
Foot Locker's dividend eats up $38 million each and every quarter. That may not seem like much, but given the cash-flow situation, it's a little surprising that the company hasn't already ditched the dividend. The company's balance sheet can handle less than two more quarters of the free-cash-flow losses it experienced in the first quarter before the coffers are fully tapped.
Markdowns will help convert inventory to cash, so in reality, the company likely has a bit more runway. But still, given the scope of the sales declines and free-cash-flow losses, spending over $150 million annually on a dividend doesn't seem sustainable anymore.
Foot Locker still expects to be plenty profitable on an adjusted basis in 2023, although it gutted its guidance along with the first-quarter report. The company expects to report adjusted earnings per share of between $2.00 and $2.25, down from a previous guidance range of $3.35 to $3.65. Those adjusted earnings would cover the dividend, but the company can't use accounting profits to send cash to shareholders. Cash flow is what matters, and it's in short supply.
Even after plunging Friday morning, Foot Locker stock trades for around 14 times the adjusted earnings guidance. Foot Locker is no bargain, and its earnings guidance could come down further if the economy continues to deteriorate this year. The dividend, which yields over 5% after Friday's rout, may look attractive. But don't expect it to last.
