Foot Locker (FL): The Smarter Way To Invest In Nike (NKE), Adidas (ADDYY) and Under Armour (UA)
Despite the amount of technology companies that have emerged in the 21st century, two of the greatest growth stories of the millennium are those of Nike (NKE) and Adidas (ADDYY). They had a combined market cap of $19.2 billion on 1/1/2000, today that number has swollen to $92 billion. Under Armor (UA) has also emerged in that time, and sports a $8.5 billion valuation. The athletic apparel industry has been one of the most successful sectors of the past 20 years and continues to grow at a brisk pace. With the world becoming more and more educated everyday on the importance of physical fitness, the popularity of sports rising throughout the world, and the continued emergence of the middle-class consumer in Asia, this is an industry that will continue to outperform for years to come. I expect one could do reasonably well for themselves by simply buying a basket of stock in NKE, ADDYY, UA. However, I believe one can invest in these companies’ continued growth at a better price by simply buying shares of Foot Locker (FL).
Foot Locker dominates the retailing of performance and casual athletic shoes in shopping malls and online in the United States. Outside of Finish Line (FINL), Foot Locker’s portfolio of brands contains nearly every other popular mall-based athletic shoe store, consisting of Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports, and Footaction Their online operations are composed of the company’s aforementioned stores’ websites and Eastbay. Foot Locker ended Q2 with 3,495 company owned stores, 2,482 in the US and 1013 international locations, reflecting a closing of 42 storefronts in the US and an increase in store count internationally by 202. This is a positive trend for shareholders as the company closes unprofitable stores in the over-saturated US market and expands its presence overseas where there are far greater opportunities to grow revenues and profitability. Foot Locker also recently began franchising their stores in the middle east and South Korea, in the past year the number of such stores has nearly doubled to 69.
Foot Locker’s $600 Million Buyback Plan, Shareholder Friendly Management Team
Foot Locker’s management team, led by CEO Kenneth Hicks, has a strong track record and a history of undertaking share-holder friendly initiatives. In February Foot Locker presented their 2013 Capital Allocation Plans to investors, announcing an 11% dividend increase to $0.20 per quarter and a $600 million buyback program extending through January 2016, replacing their previous $400 million program under which they had spent $129 million since 2012. With a market cap of $5 billion, the new buyback program will the number of shares outstanding by more than 10% , thus increasing FL’s earnings per share. The current program is well ahead of schedule with $100 million worth of shares repurchased during Q2 alone. I believe management will continue to buyback aggressively with FL shares currently trading $1 below the average price paid to repurchase the first $100 million worth of shares under the program. This could lead to a future hike in their buyback plan being announced sooner than later, certainly a potential positive catalyst for shareholders to watch out for. With a net cash position of $700 million and levered free cash flows over $300 million annually, Foot Locker is in an extremely enviable financial position, that gives them the flexibility to keep returning significant amounts of capital after reinvesting for growth.
Foot Locker Is Undervalued Relative to Their Peers in the Athletic Apparel Sector
Despite their strong balance sheet, dominant position in mall-based and online retailing, and efforts to unlock value for shareholders, shares of Foot Locker currently trade at a steep discount to rest of the athletic apparel sector. Using any valuation metric Foot Locker trades at a lower multiple then their peers, fellow retailers and apparel companies alike.
As we can see pretty clearly, Foot Locker has at the lowest sales and profitability multiples of the group and trades at a huge discount to their peers in terms of enterprise value/ free cash flow.
FL Is A Buy At Current Levels
Foot Locker is a long-term buy at today’s closing price of $34.20 per share. This company has numerous things going for it that make it one of our top picks at present. Athletic apparel has been one of the strongest and most consistent growth sectors of the past 20 years. While most clothing designers and retailers are wildly susceptible to changes in fashion and styles, sports never go out of style. Almost anyone playing soccer, basketball, baseball, football, exercising in their local gym, or jogging in their neighborhood, is doing so in sneakers and clothing made by Nike, Adidas, Reebok (owned by Adidas) or Under Armour. As NKE and ADDYY go, so does FL since 1/1/2000, with NKE up 534%, ADDYY up 368%, and FL gaining 416%.
As a believer in the long-term sustainable growth prospects of the athletic apparel industry, therefore a believer in Nike, Adidas, and Under Armour, I view Foot Locker as a way to gain direct exposure to these businesses fortunes at a steep discount to their own valuations. Management has a proven track record of utilizing capital effectively and is aggressively buying back shares, which should unlock shareholder value long-term. They also pay a not insignificant dividend yielding 2.4% annually. All things considered, Foot Locker should be trading at valuations at least in line with their peers if not in excess of them. The group average EV/ FCF of 32.9 is rather high. Lets assume long-term that a 18-22 would represent a more normalized range. If Foot Locker can grow their free cash flow by 8.5% per year for the next 3 years, a number we think is very reasonably attainable, they will be generating FCF of $400 million per year by 2016. Based on the low-end of our conservative valuation range (EV/ FCF= 18), I believe Foot Locker will have an enterprise value of at least $7.2 billion within 3 years, representing an upside of 68% from today’s price or $58 per share. Our price target becomes $61 if dividends are taken into account.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article.