Can Foot Locker Regain its Footing?

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

Foot Locker (NYSE: FL) and its associated stores are a common sight at American malls. The company, which is often the first stop for U.S. shoppers looking for athletic footwear and apparel, survived the recession and emerged far stronger than before - posting three straight years of consecutive earnings growth.

Yet the stock recently plunged over 7% after it reported fourth quarter earnings that didn’t quite satisfy Wall Street. Was this just a temporary slip, or has Foot Locker really lost its footing?

Business Operations

In addition to its namesake stores, Foot Locker also owns Champs Sports, Footaction USA and Eastbay/  Foot Locker operates 3,335 stores across 23 countries in North America, Europe, Australia and New Zealand. The company also has 42 franchised stores in the Middle East and South Korea.

Fourth Quarter

For its fourth quarter, Foot Locker earned an adjusted $0.73 per share, representing a 28% increase from the previous year and matching analyst estimates. 

The company’s revenue rose 14% to $1.71 billion, topping the consensus estimate of $1.69 billion. Sales growth outpaced merchandise inventory growth, which rose 9% to $1.7 million - a strong indicator that it is turning over its inventory at a healthy rate.

Same-store sales growth rose 7.9%, which came in far higher than its industry peers - many of whom were lucky to even post 5% same-store sales growth during the weaker-than-expected holiday shopping season. Industry rival Finish Line (NASDAQ: FINL) posted less than half of Foot Locker’s growth, at 3.6%.

Fundamentally, Foot Locker’s earnings appeared robust, and marked its 12th consecutive quarter of earnings and same-store sales growth. However, both its top and bottom line growth were aided by an extra week in the fourth quarter. Therefore, some investors were unimpressed that Foot Locker merely met expectations on profit while barely beating on sales. As a result, shares plunged more than 7% after the company released its earnings report on March 8.

New Store Concepts

During fiscal 2012, the company closed 119 stores, opened 85 new ones and remodeled or relocated 198 locations.

Remodeling its existing locations is a major part of Foot Locker’s primary strategy. As a result, the company expects to spend 35% more on capital expenditures in 2013. Throughout 2012, the company tested new prototype stores for nearly all its main stores, such as its namesake stores, Lady Foot Locker and Champs Sports.

These renovated stores are expected to complement new product lines from Nike and Adidas, which feature brighter colors and new technological enhancements. Demand for these new products has fueled the athletic footwear and apparel industry’s steep recovery since the end of the recession. Shares of Adidas and Nike have risen 250% and 170%, respectively, over the past four years.

The new Champs Sports stores have been remodeled drastically, with shoes moved to the center of the store while athletic apparel was moved to the walls, a reversal from its previous store model. The stores also feature a shop-in-shop concept, to promote a more “boutique-like” shopping experience. Several of the newly renovated locations also feature a Nike-exclusive concept store called “The Yardline”, which offers NFL-branded athletic gear.

Lady Foot Locker, the company’s worst performing brand, is being renovated as well. The company is attempting to address the fact that in athletic stores, men look for shoes first, while women start by focusing on apparel.

Therefore, Foot Locker is testing a new female-focused concept store called SIX:02 in three locations in Texas, Connecticut and New Jersey. SIX:02 offers more yoga and running gear than Lady Foot Locker, in a bid to emulate the success of Lululemon Athletica (NASDAQ: LULU), which grew yoga apparel from a niche market into a mainstream one.

Foot Locker’s gradual store enhancements have boosted its average sales per square foot to approximately $400 - a 22% improvement over the past two years. By comparison, Finish Line finished fiscal 2012 with sales of $339 per square foot.

Full Year Earnings and Guidance

For the full year, Foot Locker earned $2.58 per share, or $397 million, compared to $1.80 per share, or $278 million, it earned in 2011. Its annual revenue rose 10% to $6.18 billion.

Looking ahead, Foot Locker forecasts 2013 earnings per share to rise by a “double-digit” percentage from 2012.  That is roughly in line with current estimates for earnings of $2.83 per share, a 15% increase.

Rising Expenses

Several analysts, such as Janney analyst Eric Tracy, expressed concerns regarding Foot Locker’s rising expenses. During the fourth quarter, SG&A (selling, general and administrative expenses) rose by 12% to $363 million from the prior year quarter, and as seen in the chart below, represent its highest levels in the past decade.

<img alt="" src="" />

FL SG&A Expense Quarterly data by YCharts

Foot Locker attributed these rising costs to more aggressive marketing and renovations - a strategy that the company does not expect to change in 2013.

However, should investors be worried? Let’s gauge how Foot Locker stacks up to its rival Finish Line, as well as two high momentum challengers in the market - Lululemon Athletica and Under Armour (NYSE: UA).

Although Lululemon and Under Armour - which offer their own branded products - have far smaller retail footprints than either Foot Locker or Finish Line, their success has forced traditional athletic retailers to rethink their business models.

<table> <tbody> <tr> <td> </td> <td><strong>Forward P/E</strong></td> <td><strong>5-year PEG</strong></td> <td><strong>Price to Sales (ttm)</strong></td> <td><strong>Debt to Equity</strong></td> <td><strong>Return on Equity (ttm)</strong></td> <td><strong>Profit Margin</strong></td> </tr> <tr> <td><strong>Foot Locker</strong></td> <td>11.55</td> <td>1.13</td> <td>0.89</td> <td>5.81</td> <td>17.07%</td> <td>6.26%</td> </tr> <tr> <td><strong>Finish Line</strong></td> <td>11.29</td> <td>1.12</td> <td>0.62</td> <td>No debt</td> <td>15.29%</td> <td>5.43%</td> </tr> <tr> <td><strong>Lululemon Athletica</strong></td> <td>31.08</td> <td>1.39</td> <td>7.81</td> <td>No debt</td> <td>36.39%</td> <td>18.68%</td> </tr> <tr> <td><strong>Under Armour</strong></td> <td>27.15</td> <td>1.63</td> <td>2.88</td> <td>7.59</td> <td>17.72%</td> <td>7.02%</td> </tr> <tr> <td><em>Advantage</em></td> <td>Foot Locker</td> <td>Finish Line</td> <td>Finish Line</td> <td>Finish Line/Lululemon</td> <td>Lululemon</td> <td>Lululemon</td> </tr> </tbody> </table>

Source: Yahoo Finance, March 9.

The appeal of Lululemon is undeniable - remarkable past performance based on robust return on equity, high margins, no debt and a steadily declining P/E ratio that is reconciling with its share price. Under Armour, which hasn’t been able to match the strength of Lululemon over the past five years, remains a strong second choice for growth investors.

Meanwhile, Foot Locker is a steady, undervalued choice that has posted admirable price growth over the past three years, with a lower beta than its peers.

<img alt="" src="" />

FL data by YCharts

The Foolish Bottom Line

Foot Locker is a fundamentally stable, growing stock. Although it lacks the high momentum appeal of Lululemon or Under Armour, it is handily outperforming its closest industry peer, Finish Line.

As long as demand for athletic footwear and apparel rises - reflected in Nike and Adidas’ strong top and bottom line growth - then Foot Locker will be lifted as well, without being exposed to the performance of a single brand.

Last but not least, Foot Locker’s aggressive investments show that it is seriously addressing the importance of female shoppers, and the way both men and women shop at its stores.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica, Nike, and Under Armour. The Motley Fool owns shares of Nike and Under Armour. 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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