In 2008, as the Great Recession was gaining momentum, business was bad for shoe retailer Foot Locker (FL +0.00%). During its fiscal 2008 (which ended in January 2009), sales dropped almost 4% year over year (YOY), and the company had an operating loss of $103 million. The market consequently gave up on the stock.
Shares of Foot Locker hit their lowest valuation over the last 20 years in November 2008. At their lowest point, shares traded for just 0.16 times trailing sales, as the chart below shows.
FL PS Ratio data by YCharts
Even the pickiest value investor would agree Foot Locker stock was cheap at that valuation. But it reflected the extremely low confidence that investors had in the company. The stock was priced as if the bad times would continue forever.
But better days came. In Foot Locker's fiscal 2009, sales dropped another 8%. But its profits recovered as the company reported $80 million in operating income. And investor confidence came surging back.
The surge in stock price happened just as fast. Counting reinvested dividends, Foot Locker stock gained 1,600% from Nov. 21, 2008 through Sept. 25, 2015 -- that's a 17-bagger in less than seven years. The 180% total return for the S&P 500 during this time looks utterly boring by comparison.
FL Total Return Level data by YCharts
Here's the kicker: Foot Locker stock has traded at less than 0.2 times trailing sales only one other time in the last 20 years. And that other time is right now.
For this reason, investors understandably want to know if Foot Locker stock is a deep value stock today, capable of market-crushing returns when investor sentiment improves. It's certainly possible. But I'll explain why I believe it will be an uphill battle.
But first, what went right last time?
It's easy to point out what went right for Foot Locker during its epic seven-year run. Its sales valuation went up more than 800% as its profits bounced back. For perspective, it had net income of $541 million in 2015, good for a 7.2% profit margin and well ahead of its 2009 profit. Perhaps surprisingly, the company's top line barely moved during this time, as the chart below shows.
FL Total Return Level data by YCharts
The hill that Foot Locker must climb now
Today, Foot Locker's management recognizes that the upside for its business is modest. Through the end of 2026, it's targeting only 6% sales growth from 2023. And over the long term, it's hoping to surpass $10 billion in sales. For perspective, it had about $9 billion in sales in 2021. The market opportunity is simply limited.
This can be OK. After all, Foot Locker didn't grow revenue much last time, and it still handily beat the market over an extended period. The question, therefore, is whether the company's profitability can recover.
To answer this question, I want to talk about what's changed since the last time Foot Locker stock was so cheap. Even a decade ago, e-commerce for shoe stocks was still a small thing. But it's much bigger now and is poised to get bigger still.
According to Statista, U.S. e-commerce revenue for apparel, footwear, and accessories climbed from about $90 billion in 2017 to almost $184 billion in 2022 -- more than double in five years. And by 2027, it's expected to be a $305 billion market.
Embedded in its long-term guidance, Foot Locker's management hopes to grow e-commerce sales to 25% of its business. And it wants its loyalty members to account for more than 70% of sales. But I believe it's fair to wonder why consumers would be loyal to Foot Locker's e-commerce channel when shoe companies have their own.
Indeed, Foot Locker's loyalty numbers are already trending the wrong way. In its fiscal 2023's second quarter, which ended in July, sales from loyalty members dropped to 22% of total sales, compared with 24% in the prior-year period.
I believe Foot Locker is getting disintermediated because of e-commerce. In times past, its competitive advantage was the breadth of its selection of in-store products. But now consumers can find anything direct from the shoe companies, and they consequently don't need to be loyal to Foot Locker.
Foot Locker could offer good deals to keep itself in the conversation. But promotional activity reduces profit margins -- that's why its profits are down so far in 2023.
Because of all this, I believe Foot Locker will be fighting an uphill battle to expand its profit margins. In other words, I don't want to invest in this stock today. Betting that its profits bounce back and the stock's valuation recovers is just too risky for me.
