This Shoe Retailer Is an Interesting Opportunity

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Since the beginning of the year, Foot Locker (NYSE: FL) has gained around 8.8%, lagging the S&P 500 return of more than 15%. Recently, author Jack Hough featured this stock in Barron’s, arguing that it has a potential upside of around 25%. Is it a good buy at its current price?

Consistent improvements

Foot Locker, incorporated in 1989, is the shoes and apparel retail operator of more than 3,330 primarily mall-based stores around the world. Most of its revenue, $5.57 billion, or 90.1% of the total 2012 revenue, was generated from the Athletic Stores segment while the Direct-to-Customers segment contributed only $614 million in revenue. In the past five years, Foot Locker has consistently improved its operating performance, boosting its sales and net income. While revenue increased from $5.24 billion in 2008 to nearly $6.2 billion in 2012, its operating income rose from a loss of -$79 million to a high profit of $397 million. EPS grew from -$0.52 per share to $2.58 per share during the same period.

What makes me interested in Foot Locker is its consistent growth in its comparable store sales. In 2012, its comparable store sales growth was as high as 9.4%. Moreover, Foot Locker has quite a strong balance sheet. As of Jan. 2013, it had nearly $2.38 billion in equity, $928 million in cash and short-term investments, and only $133 million in long-term debt. Foot Locker is trading at nearly $35 per share, with a total market cap of around $5.4 billion. The market values Foot Locker at only 5.7 times EV/EBITDA.

EV/EBITDA represents enterprise value divided by earnings before interest, taxes, depreciation and amortization. This ratio reflects the total value of the company after the cash and debt level are adjusted, compared to the cash flow position of the company. The lower the ratio, the cheaper the stock.

Income investors would prefer Foot Locker

Compared to its peers Dick’s Sporting Goods (NYSE: DKS) and Finish Line (NASDAQ: FINL), Foot Locker has the highest operating margin of the trio. In the past 12 months, Foot Locker’s operating margin was nearly 10.17%. Dick’s ranked second with around 8.93% operating margin while the operating margin of Finish Line was the lowest at 8.21%.

Dick’s has been quite a cash cow, generating an increasing free cash flow, from $32 million in 2003 to $219 million in 2012. Dick’s also possesses a strong balance sheet, with nearly $1.58 billion in equity and only about $16 million in long-term debt and leasing obligations. For the full year 2013, Dick’s expected to grow its same store sales by 2% to 3%, opening 40 new Dick’s Sporting Goods stores and one new Golf Galaxy store. The non-GAAP earnings, excluding impairment charges would come in at around $2.53 per share. Dick’s is trading at $52.20 per share, with the total market cap of around $6.6 billion. The market values the company the most expensively, at 9.84 times EV/EBITDA.

Finish Line is the cheapest company among the three. At $21.20 per share, it is worth around $1 billion. It is valued at only 5.4 times EV/EBITDA. In the recent fiscal year 2013, Finish Line experienced decent growth in its comparable store sales of 5.9% with the net sales of $1.44 billion. EPS came in at around $1.40 per share, a bit lower than the EPS of $1.59 per share last year. The lower earnings were due to higher cost of sales (including occupancy costs) and the impairment charges of nearly $5.6 million. In the next year, Finish Line estimated a mid-single digit percent year-over-year growth in EPS, with the non-GAAP EPS of around $1.47 per share. Glenn Lyon, the company’s chairman and CEO commented that the company would keep on its growth strategies for its Finish Line, Macy’s and The Running Company businesses for the long-term benefit of shareholders.

Income investors might like Foot Locker the most because it offers the highest dividend yield at 2.3%, Finish Line ranked second with 1.3% dividend yield while Dick’s only pays dividends with a yield of 1%.

My Foolish take

Among the three, I like Foot Locker the most due to quite a low valuation, highest operating margin and the juiciest dividend yield. According to Barron’s, its share could grow 25% to $43 per share within a year. Personally, I think with the growing profits and cash flow, Foot Locker could increase both dividends and share buybacks in the next year to deliver more value to its shareholders. 

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Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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