Over the last six months, Foot Locker’s shares have sunk to $22.41, producing a disappointing 15.9% loss - a stark contrast to the S&P 500’s 9.3% gain. This was partly driven by its softer quarterly results and might have investors contemplating their next move.
Is there a buying opportunity in Foot Locker, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.Even with the cheaper entry price, we don't have much confidence in Foot Locker. Here are three reasons why FL doesn't excite us and a stock we'd rather own.
Why Do We Think Foot Locker Will Underperform?
Known for store associates whose uniforms resemble those of referees, Foot Locker (NYSE:FL) is a specialty retailer that sells athletic footwear, clothing, and accessories.
1. Shrinking Same-Store Sales Indicate Waning Demand
Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.
Foot Locker’s demand has been shrinking over the last two years as its same-store sales have averaged 2.5% annual declines.
2. EPS Trending Down
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for Foot Locker, its EPS declined by 28.9% annually over the last five years while its revenue was flat. This tells us the company struggled because its fixed cost base made it difficult to adjust to choppy demand.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Foot Locker’s $2.84 billion of debt exceeds the $211 million of cash on its balance sheet. Furthermore, its 8× net-debt-to-EBITDA ratio (based on its EBITDA of $340 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Foot Locker could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Foot Locker can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
Foot Locker doesn’t pass our quality test. Following the recent decline, the stock trades at 10.9× forward price-to-earnings (or $22.41 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - you can find better investment opportunities elsewhere. We’d suggest looking at Wingstop, a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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