FootLocker FL
August 17, 2005 - 11:15am EST by
spence774
2005 2006
Price: 21.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,430 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Footlocker stock is very safe and trades at 62% of its intrinsic value. FL is the premier athletic footwear retailer in the United States commanding 20% of the $16 billion dollar US athletic footwear market and 8% of the $10 billion dollar European market. The company has no net debt, produces strong free cash flows and has a share-holder friendly management team. Management recently pre-announced sales. Full earnings will be released this Thursday after market close (8/18) with a call on Friday morning.

In March 2003 manv785 did a great job writing up this idea at $10.78. Now the stock has doubled but the management team is further along in their turn-around plan and the valuation today is similar to what it was then. This write up will serve to update VIC members on the numbers and the current state of the turn-around plan.

EBIT margins are 7.4% but management has a credible plan to improve them to 8.5% in the ‘very, very’ near term and 10% ‘longer-term’.

In the late 90’s and early 2000 FL experimented with a large footprint concept that combined many of their brands into a single location. Management has repeated that this has been an utter flop and as these leases come up for renewal FL has been abandoning the concept and replacing them with more productive, smaller, single-themed stores.

Management is improving margins by renegotiating leases at mall based stores, opening cheaper off-mall stores, and closing unproductive stores as their leases expire. Additionally, as FL grows and gains density in Europe, Asia and the US they should continue to benefit from scale and improve margins.

In the past 2 years, sales/square foot has increased from $316 to $345 and the balance sheet has improved from a net debt to a net cash position.

DESCRIPTION:

Footlocker operates 6 major brands:
Footlocker: 2,135 stores, target customer 12-20 year olds
kidsFootLocker: 346 stores, target customer 6- 11 year olds
Champs: 570 stores, target customer 10 -25 year olds. Apparel, equipment and footwear
FootAction: 349 stores, target urban youth, fashion forward street wear
Lady FootLocker: 567 stores; target 18-29 year old females
Total: Just under 4,000 stores world-wide
Footlocker.com/Eastbay: Direct to customer channel (Internet/Catalog)
Domestic Stores make up 67% of sales (down from 83 % 6 years ago)
Direct to customer is 7% of sales
International has gone from 12% of sales in 1998 to 26% of sales in 2004

FINANCIAL SUMMARY:

LTM Revenue: $5.6 B
EBIT margins: 7.4%
MGMT short-term EBIT goal: 8.5%
MGMT Long-term EBIT goal: 10%

FULL YEAR PROJECTIONS:

Revenue 2005E: $5.7 B
Revenue 2006E: $5.9 B
Revenue 2007E: $6.1 B

2005 EBITDA: $616 mm
2006 EBITDA: $696 mm
2007 EBITDA: $780 mm

2005 EBIT: $456 mm (@8% EBIT)
2006 EBIT: $531 mm (@9% EBIT)
2007 EBIT: $610 mm (@10% EBIT)

2005 Total Cap-Ex: $180mm
2006 Total Cap-Ex: $180mm
2007 Total Cap-Ex: $180mm

2005 FCF: $276 mm. 162.6 mm f/d shares = $1.70/share
2006 FCF: $327 mm. 167.5 mm f/d shares = $1.95/share
2007 FCF: $381 mm. 172.5 mm f/d shares = $2.21/share

CASH BUILD:

Fiscal 2005E Net Cash $376 mm
Fiscal 2006 Cash Build $327 mm
Fiscal 2006 Cash from Options $107 mm
Fiscal 2007 Cash Build $381 mm
Fiscal 2007 Cash from Options $110 mm
TOTAL JAN 08 $1301mm
CASH per Share $1301mm/172.5 f.d shares= $7.54

VALUATION

2007 FCF $2.21/share * 12.5 = $27.63
Plus $7.54 in cash
Stock Price of $35.17

KEY ASSUMPTIONS:

Retail square footage expansion of 1-2%
Year over year Same Stores Sales and Internet/Catalog growth of 1-2%
Vest all options and take in cash
3% year over year share growth
Ignore Interest Income/Expense
No major acquisitions
$155 mm in pension/retirement under funding that we haven’t accounted for
FCF approximates cash build
36.5% Tax Rate (per guidance)


RISKS:

Consumer spending slowdown
Nike accounts for 40% of product mix

Catalyst

Continuing real estate rationalization and margin improvements
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    Description

    Footlocker stock is very safe and trades at 62% of its intrinsic value. FL is the premier athletic footwear retailer in the United States commanding 20% of the $16 billion dollar US athletic footwear market and 8% of the $10 billion dollar European market. The company has no net debt, produces strong free cash flows and has a share-holder friendly management team. Management recently pre-announced sales. Full earnings will be released this Thursday after market close (8/18) with a call on Friday morning.

    In March 2003 manv785 did a great job writing up this idea at $10.78. Now the stock has doubled but the management team is further along in their turn-around plan and the valuation today is similar to what it was then. This write up will serve to update VIC members on the numbers and the current state of the turn-around plan.

    EBIT margins are 7.4% but management has a credible plan to improve them to 8.5% in the ‘very, very’ near term and 10% ‘longer-term’.

    In the late 90’s and early 2000 FL experimented with a large footprint concept that combined many of their brands into a single location. Management has repeated that this has been an utter flop and as these leases come up for renewal FL has been abandoning the concept and replacing them with more productive, smaller, single-themed stores.

    Management is improving margins by renegotiating leases at mall based stores, opening cheaper off-mall stores, and closing unproductive stores as their leases expire. Additionally, as FL grows and gains density in Europe, Asia and the US they should continue to benefit from scale and improve margins.

    In the past 2 years, sales/square foot has increased from $316 to $345 and the balance sheet has improved from a net debt to a net cash position.

    DESCRIPTION:

    Footlocker operates 6 major brands:
    Footlocker: 2,135 stores, target customer 12-20 year olds
    kidsFootLocker: 346 stores, target customer 6- 11 year olds
    Champs: 570 stores, target customer 10 -25 year olds. Apparel, equipment and footwear
    FootAction: 349 stores, target urban youth, fashion forward street wear
    Lady FootLocker: 567 stores; target 18-29 year old females
    Total: Just under 4,000 stores world-wide
    Footlocker.com/Eastbay: Direct to customer channel (Internet/Catalog)
    Domestic Stores make up 67% of sales (down from 83 % 6 years ago)
    Direct to customer is 7% of sales
    International has gone from 12% of sales in 1998 to 26% of sales in 2004

    FINANCIAL SUMMARY:

    LTM Revenue: $5.6 B
    EBIT margins: 7.4%
    MGMT short-term EBIT goal: 8.5%
    MGMT Long-term EBIT goal: 10%

    FULL YEAR PROJECTIONS:

    Revenue 2005E: $5.7 B
    Revenue 2006E: $5.9 B
    Revenue 2007E: $6.1 B

    2005 EBITDA: $616 mm
    2006 EBITDA: $696 mm
    2007 EBITDA: $780 mm

    2005 EBIT: $456 mm (@8% EBIT)
    2006 EBIT: $531 mm (@9% EBIT)
    2007 EBIT: $610 mm (@10% EBIT)

    2005 Total Cap-Ex: $180mm
    2006 Total Cap-Ex: $180mm
    2007 Total Cap-Ex: $180mm

    2005 FCF: $276 mm. 162.6 mm f/d shares = $1.70/share
    2006 FCF: $327 mm. 167.5 mm f/d shares = $1.95/share
    2007 FCF: $381 mm. 172.5 mm f/d shares = $2.21/share

    CASH BUILD:

    Fiscal 2005E Net Cash $376 mm
    Fiscal 2006 Cash Build $327 mm
    Fiscal 2006 Cash from Options $107 mm
    Fiscal 2007 Cash Build $381 mm
    Fiscal 2007 Cash from Options $110 mm
    TOTAL JAN 08 $1301mm
    CASH per Share $1301mm/172.5 f.d shares= $7.54

    VALUATION

    2007 FCF $2.21/share * 12.5 = $27.63
    Plus $7.54 in cash
    Stock Price of $35.17

    KEY ASSUMPTIONS:

    Retail square footage expansion of 1-2%
    Year over year Same Stores Sales and Internet/Catalog growth of 1-2%
    Vest all options and take in cash
    3% year over year share growth
    Ignore Interest Income/Expense
    No major acquisitions
    $155 mm in pension/retirement under funding that we haven’t accounted for
    FCF approximates cash build
    36.5% Tax Rate (per guidance)


    RISKS:

    Consumer spending slowdown
    Nike accounts for 40% of product mix

    Catalyst

    Continuing real estate rationalization and margin improvements

    Messages


    Subjectmargins vs. FINL
    Entry08/17/2005 12:28 PM
    Memberdanarb860
    you think FL margins can exceed FINL?

    SubjectEBIT Margins
    Entry08/17/2005 04:41 PM
    Memberruby831
    what are the steps in managements plan to get EBIT margins to 10% - for past 10 years they have averaged 4.5% (median 5.3%) with an all time high of 8.8% in 1997 and low of -1.7% in 1999


    SubjectMargins and Competition
    Entry08/18/2005 08:51 AM
    Memberspence774
    Margins:
    On an LTM basis FINL had a 31.7% Gross margin versus FL’s 30.5%

    We believe FL’s leading position in the market place and with suppliers would imply that they would get pricing and terms at least as good as FINL thus being able to achieve at least a 31.5% GM as well. With the NIKE feud in the past we see GM marching upward.

    A 100 BP improvement on GM puts FL at the 8.4% EBIT margin, and then further leverage from real estate rationalization and scale will lead to the other incremental margin improvements ultimately getting to the target 10% EBIT levels.

    The real estate rationalization plan includes closing underperforming stores, renegotiating leases and closing the large footprint stores and returning to single concept ones.


    Competition:
    The product at FL is having a wide selection of shoes that are always in stock when you want them. Lots have argued that Wal-Mart would get access to Nike, but we think Nike is smart enough to know that such an action would decimate their brand, or at they very least the marquee product.

    At the end of the day Nike is a brand, as are most other pieces of high-end athletic footwear and part of building that brand means promoting it through select retail channels. We don’t worry about Wal-mart, Target, DSW or the like because Footlocker is ultimately competing for a different customer.

    Recently, Nike decided to pull their product from Sears. Here’s a link to an article concerning the topic.

    http://in.news.yahoo.com/050504/137/5yeud.html

    Dick’s is a major competitor but there’s plenty of room for more than one player. When a customer goes to Footlocker, or one of the 6 concepts, they know what to expect both in terms of quality and breadth of selection- that’s why they come.

    The recent dispute with Nike sheds some light on how important FL is to them (and vice-versa).

    Unlike most other mall based retailers Footlocker takes little fashion risk. If Reebok hits the ‘in’ shoe instead of Nike in a given year, it is easy to change product mix. With Footlocker you’re buying a superior distribution channel that is valued by both the supplier (Nike, Reebok etc) and the customer- that’s a combination that is both rare and valuable.


    Subjectresponse
    Entry08/18/2005 12:20 PM
    Memberdanarb860
    I don't necessarily disagree with what you write. I am just not sure the FL business is a structurally 10% margin business. It is true that ewvents have shown that NKE needs FL, but the vendor base is still very concentrated. Also, the margin story, in part driven by the real estate has been hanging around for a while now. A lot of the bad leases have been rolling off already. I think Europe is a key to this story

    SubjectFootaction's impact on margins
    Entry08/18/2005 02:32 PM
    Membermatt366
    The real estate story has been kicking around, because it takes time to accomplish. FL's margin expansion the past couple of years has been solid, and is obscured by Footaction's having a 50bp negative impact on the margins in 2004. Europe is important for sure, but the execution here on the margin front has been solid.

    SubjectCall Highlights
    Entry08/19/2005 11:35 AM
    Memberspence774
    Highlights



    Full year EBIT margins should hit 8% this year

    10% EBIT is 2-4 years away depending on host of things but definitely within reach

    Inventory levels were up but will be cleaned up by the end of the year

    Entered Greece and Switzerland this year

    Cash marched up slightly to $360 mm

    Renegotiated real estate is 200bps better than the company average on the non-rationalized assets- still 150 BPS opportunity over the next ‘few’ years

    Gross margin pressure in Europe

    US biz is on fire.

    Tax rate for the quarter was 38% (up slightly from 36.5% guidance)

    Subjectcheap at this price?
    Entry08/16/2007 02:55 PM
    Memberfinn520
    Any thoughts on FL at these prices? At $14.95, and assuming 3.3% EBIT margins in 2007 and 6.5% in 2008 (roughly 10 year average), you are getting the business at 4.8x 2008 EV/EBIT, or roughly 12.9% aftertax FCF yield on 2008 numbers assuming cash build.

    Sure, there could be some rough sledding in the next year or two if the swing from athletic shoes to brown shoes continues, a la the late 1990's, but this is starting to look pretty cheap on normalized basis.

    Wonder if Serna will buy back at these prices. But hey, why buy your own company at 8x FCF when you could buy a competitor at twice the price?
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