FL - Foot Locker

[JayGatsby]

We had a bit of a discussion of this in the retail thread, but thought I'd start one here.  Think it's interesting given valuation and current financials, but it's stayed a real small position for me. The real dumpster bin companies here are Hibbett and Big 5 which are below book value of inventory. Foot Locker seems like the best of breed of the sportwear distributor boxes, for whatever that may be worth.

Pros:

1. Attractive trailing valuation: Less than 6x PE when adjusted for cash. Most of this is going to repurchase shares (or currently sitting on the balance sheet)

2. Shoes actually have some compelling reason to go to the store, particularly for kids.

3. Low cost structure / high EBITDA margin. This may give them some benefit if stores like Hibbett or Big 5 close stores. EBITDA Margin (on a trailing 12 basis, so most are materially better than on a forward 12 basis):

  a. Foot Locker: 13.8%

  b. Finish Line: 5.2% (Could be an interesting acquisition target for FL at some point.. they have the cash and wouldn't be paying terribly more than inventory value. The margin difference is nearly entirely on gross margin.. not sure why)

  c. DSW: 6.8%

  d. Dick's: 6.1%

  e. Hibbett: 9.8% (basically 0% last quarter)

  f. Big 5: 5.3%

4. Some internal diversification (although all are fairly correlated). While being fairly ignorant on it overall, I think international retail is probably better than US retail because it tends to be more pedestrian, rather than a 1980s box. Here's the store name with 4.5 year change in store count and current store count:

  a. Foot Locker US (932 stores): -13%

  b. Foot Locker Europe (624 stores): +6%

  c. Foot Locker Canada (117 stores): -9%

  d. Foot Locker Asia (97 stores): + 5%

  e: Kids Foot Locker (432 stores): + 42%

  f: Lady Foot Locker (112 stores): -63% (see six:02 below)

  g: Champs Sports (546 store): +1%

  h: Footaction (262 stores): -7% (I think this is a down market brand... not sure?)

  i: Runners Point (122 stores): +5%

  j: Sidestep (84 stores): +8% (some markets in Europe)

  k: Six:02 (31 stores) (spun out of Lady's I think)

  l. They also have a direct consumer that did ~$150M of op income last year. I'm not sure what happens to that if the stores were to close down.

5. Inventory is ~30% of current price. So not a full backstop, but it helps if you were to model a wind-down.

 

Cons:

1. Just a distributor. No real moat or IP. Suppliers are trying to go direct to consumer

2. Internet. Malls are losing traffic.

3. Seems to be more of a fashion store than an athletic shoe store

 

Earnings on friday. Curious people's thoughts / personal shoe buying habits.

There's a Finish Line thread here: http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/finl-finish-line/

[DTEJD1997]

Jay:

 

FINL is on my "watch closely" list.  It's current valuation is pretty compelling.

 

With that being said, I think the smart money is on a bad report/bad market reaction on Friday.

 

I think closing of BGFV might be a ways off...they too have a pretty solid balance sheet and are still profitable!

 

I think it is more likely that FINL will pick up market share from SHLD & JCP & M & traditional department stores going under, scaling back their offerings.

 

I would be interested to see what the length of FINL leases are...and how likely HQ is to close bad/underperforming locations going forward.

 

I don't personally shop at FINL, as my shoe needs at this point in time are rather basic.  I have actually gotten gym shoes at SHLD, as they sometimes have "crazy" deals.

 

At my local "C grade" mall, FINL is actually one of the stores that appears to do a pretty robust trade.  Sneakers are VERY popular, and a very serious business to the main demographic that patronizes the mall.  Every so often, there are stories on the local news about people lining up the night before for a new "Air Jordan" release.

 

Unfortunately, there are also a legion of stories about foolishness transpiring at FINL:

 

 

 

And then of course you've got the stories about the FINL having to close down because too many  of their customers wanting to "throw down" while waiting to buy children's sneakers:

 

http://detroit.cbslocal.com/2016/03/05/chaotic-crowd-looking-to-buy-new-air-jordan-shoes-forces-eastland-mall-to-close/

 

So I guess it is good that people want the product FINL has...bad that they start brawling...

 

So I would posit that FINL is very interesting candidate for sure.

 

[Guest Cameron]

I worry about the cash position on the balance sheet of FINL, as well as the FCF. P/E looks to high for me as well. With retailers, once the bleeding with cash starts to happen you have to start the clock, luckily signs show up in the numbers before the common stock is wiped out. This shows up in the quick and current ratios, quick is the one I look at with a fine tooth comb when it comes to retailers now a days as any retail bankruptcy that we have had has a pattern of seeing quick ratios falling. FINL has seen its quick ratio fall and that cash position can be wiped pretty quick, just look up HHGregg on Morningstar. FL on the other hand has seen its cash position, and quick ratio increase and now sits at 2.22 its highest in at least 10 years and current ratio sits at 5.63 which is a 10 years high.

 

But back to cash flow in its 2016 annual report FINL reported $90 million in FCF which on the surface looks good but they had a ballooned one off OCF of $164 million and this normalized in its recent 26 weeks report. I like that they have cut back on capex so they had $67 in OCF 26 week ended and $20 million in capex so they are cutting back enough to maintain the high FCF, I just don't know how long they are going to be able to keep up with falling profits.

 

DTEJD do you have any info on how much of the capex comes from the discontinuing operations? Companies that have discontinuing operations in every report sort of puts me off.

[JayGatsby]

Thanks for the feedback. That's interesting about people lining up at FINL. I guess they could go direct to consumer for that, but there probably is some merit to the idea that the lines create a look of scarcity value and increase demand. Buying something on an app is convenient, but not exciting. FINL definitely fits more in the deep value bucket given they don't trade for much above inventory value. Having said that, the things I don't like about them are:

1. They're very tied to Macy's. They operate 573 stand-alone FINL stores and 374 branded stores within Macy's. They also operate unbranded stores within Macy's, although they don't quantify that. As of end of 2016 there were 673 Macy's, which is exactly 100 stores less than at the end of 2014... not a slow decline.

2. Their gross margin is ~7% worse than FLs. I don't know if that's because FL is getting volume discounts, charging more for products or has a different mix. Regardless, I think the additional margin creates some margin of safety for FL that you don't get with FINL. FINL's 2.3% trailing EBIT margin doesn't leave a lot of room for declining comps.

 

Cameron, do you think the quick ratio falls for these retailers because they're a) losing cash, b) cutting inventory, or c) stretching payables? It's an interesting concept and I don't fully understand it to be honest. Would like to understand better how you look at that. With shoes I think you want to have a very full inventory. If I need a size 11 and you don't have a size 11 the next time I'll probably just order online in the first place. 

[Snorky]

Allan Mecham initiated a small position in FL.

 

http://www.dataroma.com/m/holdings.php?m=AV

[Guest Cameron]

Thanks for the feedback. That's interesting about people lining up at FINL. I guess they could go direct to consumer for that, but there probably is some merit to the idea that the lines create a look of scarcity value and increase demand. Buying something on an app is convenient, but not exciting. FINL definitely fits more in the deep value bucket given they don't trade for much above inventory value. Having said that, the things I don't like about them are:

1. They're very tied to Macy's. They operate 573 stand-alone FINL stores and 374 branded stores within Macy's. They also operate unbranded stores within Macy's, although they don't quantify that. As of end of 2016 there were 673 Macy's, which is exactly 100 stores less than at the end of 2014... not a slow decline.

2. Their gross margin is ~7% worse than FLs. I don't know if that's because FL is getting volume discounts, charging more for products or has a different mix. Regardless, I think the additional margin creates some margin of safety for FL that you don't get with FINL. FINL's 2.3% trailing EBIT margin doesn't leave a lot of room for declining comps.

 

Cameron, do you think the quick ratio falls for these retailers because they're a) losing cash, b) cutting inventory, or c) stretching payables? It's an interesting concept and I don't fully understand it to be honest. Would like to understand better how you look at that. With shoes I think you want to have a very full inventory. If I need a size 11 and you don't have a size 11 the next time I'll probably just order online in the first place.

 

Its a combination but its all about the concept of cash management, it basically just shows a sign of distress, so to me FL looks far from in distress at this moment at least and right now it looks like their destiny is currently in their own hands. When the quick ratio falls the destiny of the company is in the suppliers. HHGregg went bankrupt with no debt and a line of credit that they didn't tap into. If a retailers' quick ratio is falling it means they are converting their receivables to cash yet still burning through it while increasing their payables, a pretty deadly combination that can only go on for so long. Personally I haven't seen a single retailer climb out of this hole once they fall into it, I have actually been shocked at how long Sears has survived. Sears gave a full year head start in 2012 for shareholders to recognize that the tide had completely changed after its quick ratio was cut in half from 0.25-0.27 to 0.15-0.16, ever since then its been downhill.

 

I won't claim this is fool proof but it gives a pretty far heads up into the future of a retailer. To give another example, if you were a shareholder of Vitamin Shoppe for whatever reason prior to the 2016 annual report being released you could see the quick ratio deteriorating from 0.19 and finally was cut in half from it normal levels to 0.08 . Any shareholder had a full 6-8 months to recognize this before it fell off a cliff and now the quick ratio was reported as 0.03. On the other hand, one of the retailers that I bought that sentiment was pessimistic was ANF, the FCF was 1.90 a share, with the share price at $9, 8% dividend and the quick ratio was improving for years, so it was clearly not in distress even as revenues were falling. I've done this with a few retailers, but I always keep in mind that Correlation does not imply causation and that its merely one ratio to look at.

 

Obviously not fool proof, but looking at Amazon its quick ratio was hovering around 1 until 2012 when AWS become a much larger part of its business as they added capital leases to grow AWS, obviously the current portion would be moved to the current liabilities so it distorts the picture of the retail business so while overall Amazons quick ratio fell to 0.78 if we were to break out just the retail balance sheet the quick ratio would most likely still be around 1.

[gjangal]

if they can sustain 400mn in fcf , this looks really cheap. But with store based retail names , the challenge is how well they can maintain and grow revenues

[Guest Cameron]

if they can sustain 400mn in fcf , this looks really cheap. But with store based retail names , the challenge is how well they can maintain and grow revenues

 

If there is an overreaction to the earnings on Friday I'll take an closer look, after reading the latest annual report and skimming the rest they have on their site a hiccup in revenues hasn't been unusual for them before. Because of the pessimism towards retail I think this could be picked up in the teens if I am patient enough. I'd like it under B/V.

[gjangal]

This reminds me of how cheap KORS and RL were in the summer, all it took was a couple of quarters to numbers to come through. It almost looks like market is saying that earnings will be cut in half. I am not saying it’s  not possible given how much operating leverage is involved. That’s one differentiating factor to KORS and RL to this one. Their gross margins were pretty big

[Guest Cameron]

This reminds me of how cheap KORS and RL were in the summer, all it took was a couple of quarters to numbers to come through. It almost looks like market is saying that earnings will be cut in half. I am not saying it’s  not possible given how much operating leverage is involved. That’s one differentiating factor to KORS and RL to this one. Their gross margins were pretty big

 

I'm glad you brought those two up, KORS maintained its quick ratio when you adjust for the Jimmy Choo acquisition and it was well into the 4.00 range. RL has always had a sporadic quick ratio, and nothing seemed out of the norm looking back in terms of the their quick ratio. RL has revenue problems they are going to have to deal with pretty soon. 

[JayGatsby]

I've been thinking about the Finish Line comparison further, and I think that's actually a really important point. I did a comparison of all of the Finish Lines stores in my area (the front range of Colorado). In this area there are 21 Finish Lines, including 11 within Macy's

 

Of the 11 within Macy's, 6 of those stores also have a standalone Finish Line.

Of the 11 within Macy's, 4 malls also have a Foot Locker.

Of the 10 not in Macy's, 6 malls also have a Foot Locker.

 

Interestingly, none of these Macy's are on the closure list (for 2017). Macy's is expected to go from 673 stores at the beginning of the year to 600 stores at year end (http://www.businessinsider.com/macys-might-shut-down-more-stores-2017-5). I'd expect the closure of Macy's to be a negative for overall mall traffic, but obviously a positive for market share of other retailers.

 

The other question is which stores close first? Going back that same 4.5 years, the pace of store closures has been the same for Finish Line and for Foot Locker. I'm not sure which is a better brand. Certainly from an income statement / balance sheet perspective Foot Locker is stronger.

 

Edit: Did a similar analysis for the Atlanta, GA area. Very similar results. Lots of overlap between the two brands. They seem very similar to me, and I'd expect a lot of cannibalization between the two.

 

Edit 2: FINL's sales declined 3.3% YoY, while inventory was reduced 11.1%. Seems like a big divergence, but I may be fully into the tea leaves at this point.

[Guest MikeTheCannon]

The thing that gets me about Footlocker is that they're basically a retailer for one company. Something like 70% of their stock comes from Nike which is a bit concerning since Nike has their own retail stores these days.

[DooDiligence]

Barbarian Capital shares a Nike By You Maker Experience

 

https://twitter.com/BarbarianCap/status/921843987400491015

[Guest Cameron]

FINL is 30% owned by Sports Direct and has a 25% short interest, the sentiment on the company seems way to pessimistic, they guided way down for Q2 but FCF to price is something like 7x, forward P/E might be 19 but its below book and has 30% of its market cap in cash without any debt. The more I dig into these two companies the more I like them.

 

[Guest Cameron]

I've been thinking about the Finish Line comparison further, and I think that's actually a really important point. I did a comparison of all of the Finish Lines stores in my area (the front range of Colorado). In this area there are 21 Finish Lines, including 11 within Macy's

 

Of the 11 within Macy's, 6 of those stores also have a standalone Finish Line.

Of the 11 within Macy's, 4 malls also have a Foot Locker.

Of the 10 not in Macy's, 6 malls also have a Foot Locker.

 

Interestingly, none of these Macy's are on the closure list (for 2017). Macy's is expected to go from 673 stores at the beginning of the year to 600 stores at year end (http://www.businessinsider.com/macys-might-shut-down-more-stores-2017-5). I'd expect the closure of Macy's to be a negative for overall mall traffic, but obviously a positive for market share of other retailers.

 

The other question is which stores close first? Going back that same 4.5 years, the pace of store closures has been the same for Finish Line and for Foot Locker. I'm not sure which is a better brand. Certainly from an income statement / balance sheet perspective Foot Locker is stronger.

 

Edit: Did a similar analysis for the Atlanta, GA area. Very similar results. Lots of overlap between the two brands. They seem very similar to me, and I'd expect a lot of cannibalization between the two.

 

Edit 2: FINL's sales declined 3.3% YoY, while inventory was reduced 11.1%. Seems like a big divergence, but I may be fully into the tea leaves at this point.

 

The drop in FINL's inventory came from the sale of JackRabbit, it had 25.8M in inventory.