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07/27/15 10:00:12 AM
FOCUS STOCK OF THE WEEK

FOOT LOCKER, INC. (FL)

FOOT LOCKER, INC. : (FL)



This week's Focus Stock of the Week is Foot Locker Inc. (FL: $69.50), which carries S&P Capital IQ's highest investment recommendations of 5-STARS, or Strong Buy. As a major global retailer of athletic footwear and apparel, Foot Locker offers athletic-inspired performance products for various activities, including basketball, running, and training. As of January 31, 2015, the company operated 3,423 stores in 23 countries across the U.S., Canada, Europe, Australia, New Zealand, and others. In addition, Foot Locker also had 78 franchised Foot Locker stores in the Middle East and 20 in South Korea, as well as 27 franchised Runners Point and Sidestep stores in Germany and Switzerland.



The Athletic Stores segment (88% and 89% of total revenues and segment profit for fiscal 2015, ended January) comprises several demographically-targeted brands with retail offerings across various price points, including Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports, Footaction and SIX:02, as well as the Runners Point Group. The Direct-to-Customers segment (12% and 11%) sells directly to customers through the Internet and mobile sites for the various retail brands, forging a seamless link between e-commerce and stores.



Foot Locker is well-positioned to further benefit from newness and innovation in product offerings, and the trend of more people leading an active lifestyle. The company's offerings are manufactured primarily by leading athletic brands such as Nike, Inc., which is the company's largest supplier. In fiscal 2015, about 70% of consolidated revenues were derived from the U.S., and the remainder from international markets such as Europe, Canada, Australia and New Zealand.



Aiming to diversify and expand its international operations in Europe, the company recently made a notable international acquisition. In July 2013, it acquired Runners Point Group (RPG), a specialty athletic store and online retailer based in Germany, for 72 million euros in cash. RPG recently operated 199 stores under the Runners Point and Sidestep banners across Germany, Austria, and the Netherlands. Foot Locker also sees an opportunity to further accelerated e-commerce growth through RPG's online subsidiary, Tredex.



The company sees a near-term opportunity to accelerate same-store sales growth and to improve profitability through clearer differentiation of footwear and apparel offerings between its retail banners; development of private label apparel that complements branded assortments; closer collaboration with vendor partners on exclusive products; new merchandise displays that improve footwear and apparel adjacencies; customer service enhancements; redesign of its e-commerce sites; and investments in mobile commerce and social media.



Under its recently-updated medium-term strategic plan, the company's priorities include driving performance in its core business on improved customer engagement, intensifying its leading position in kids, expanding aggressively in Europe, increasing its apparel penetration and profitability, investing and growing its digital business, and recording exceptional growth in its women's business (anchored by its SIX:02 brand). Accordingly, Foot Locker has targeted sales of $10 billion by fiscal 2021 (versus $7.2 billion in fiscal 2015), as well as operating margins of 12.5% (versus 11.3%), gross margins of 33.5%-34.0% (versus 33.2%), and net income margin of 8.5% (versus 7.3%).



We expect total sales to advance 2.5% and 5.1% in fiscal 2016 and fiscal 2017, respectively, assuming a low- to mid-single digit increase in comparable-store sales. In addition, we note plans to add 50 to 60 new stores per year (net of closures of underperforming locations), translating into relatively modest square footage growth. We see continued strong consumer demand for basketball, lightweight and technical running shoes, and further expansion into accessories. In fiscal 2015, total sales increased 10%, on 8% higher comparable-store sales.



The operating margin will likely expand, by our calculations, to 12.1% in fiscal 2016 and 12.4% in fiscal 2017 - versus 11.3% in fiscal 2015. This margin should benefit from sales leverage on fixed expenses, control of marketing expenses and improved accessories and apparel margins, partly offset by stores remodeling. In addition, we expect productivity and efficiency improvements resulting from ongoing remodeling of existing stores. In fiscal 2015, 319 existing stores were remodeled, following on 320 such completed projections in fiscal 2014.



We think the shares offer attractive upside at current levels. Our 12-month target price is $82, implying a P/E ratio of 18.5X our FY 17 estimate, relatively ample to a projected long-term EPS growth of 11%, in our view. This forward P/E multiple, which is higher than the stock's 10-year historic average of 16.5x, also represents a modest premium to a peer group of apparel, footwear and sporting goods companies. We believe this valuation is partly warranted by a potential upside from ongoing strategic initiatives, and incremental growth opportunities in relatively underpenetrated international markets. Also, the stock recently offered a dividend yield of 1.4%, adding to total return.



Finally, we highlight some potential risks to our recommendation and target price. First, we think the company could be vulnerable to a sharp pullback in global consumer discretionary spending. Next, we note Foot Locker's relatively high supplier concentration, with a particularly large exposure to Nike (which provided about 73% of the retailer's merchandise in fiscal 2015). Also, we would be wary of a potentially material shortfall related to the company's strategic plan (and associated financial targets). Lastly, we highlight some risks of potentially severe foreign currency headwinds arising from the company's growing international operations (particularly in Europe).



S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.



 

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