Foot Locker (FL 0.23%) stock is on the discount rack right now. Shares of the footwear retailer are down 33% so far in 2023 while the broader market has rallied by 18%. That slump stands out even among other shoe sellers, such as Crocs, which is up this year, and Nike, down less than 10%.
Yet, there are some good reasons Foot Locker is underperforming the market and industry peers. Let's look at why investors should avoid this stock for now.
1. Reducing the outlook
Foot Locker's last earnings report showed surprisingly weak sales trends, with revenue at existing stores falling 9%. Nike last announced a 16% increase, meanwhile, and Lululemon Athletica is growing at a 24% clip.
In contrast with these peers, Foot Locker's management said tough industry conditions caught it by surprise as shoppers ramped up their search for bargains. "Our sales have softened meaningfully given the tough macroeconomic backdrop," CEO Mary Dillon told investors in mid-May.
That's all to say that investors have much better options available if they're looking for growth. Lululemon and Crocs each raised their 2023 growth outlook this past quarter, while Foot Locker reduced its forecast.
2. Falling profits
There's no avoiding the negative financial impact of promotions that are running through the footwear industry today. Nike has said that inventory levels still need to come down to meet up with slower demand growth trends, and price cuts are a way to make that happen. But Foot Locker is feeling a much bigger pinch from these factors.
FL Gross Profit Margin data by YCharts
The retailer's gross profit margin fell a painful 4 percentage points this past quarter and is now approaching 30% of sales. By contrast, Nike's profitability declined by 1 percentage point. Crocs and Lululemon are both boosting margins above 50% of sales. Consider either of these stocks over Foot Locker if you're looking for market-beating earnings potential.
3. This discount makes sense
Foot Locker is valued at a deep discount, one that investors haven't seen since the early days of the pandemic. You can own the stock for 0.3 times annual sales, down from its 2021 high of 0.8 times sales. Buying Lululemon will cost you nearly 6 times revenue, in contrast. Nike is valued at closer to 3 times annual sales.
But that valuation gap makes sense given Foot Locker's weaker sales and earnings trends. The retailer has less control over its future, too, as suppliers like Nike move toward a more direct selling relationship with customers. This shift toward digital sales is boosting profit margins for Nike and Lululemon while pressuring Foot Locker's business. That helps explain why Foot Locker is shrinking its store base and focused on cutting costs right now.
The retailer now sees comps falling by as much as 9% this year as softer demand runs at least through fiscal Q4. Gross profit margin will now decline to around 29% of sales, compared with the prior outlook of 31% of sales. Investors seeking a deep value might want to follow the stock over the next few quarters for signs of a rebound in these key metrics.
In the meantime, though, look toward more successful footwear specialists like Nike and Crocs.
