Foot Locker

As stated in my previous post, I bought Foot Locker Inc. (FL/NYSE) on Wednesday and the shares ended the day at $20.87. Foot Locker is the largest special athletic footwear retailer in the US and one of the largest in the world.

The stock has suffered recently because of unfavorable prospects for the industry in general, and because of weak results for Foot Locker itself. I see these as near-to-intermediate term challenges and anyone investing in Foot Locker with a time frame up to 5 years will be rewarded.

Foot Locker has a market cap above $3 billion with more than 155 million shares outstanding. The dividend yield is more than 2%. It trades for less than 1.5 times book value and for less than two-thirds annual sales. The company has a strong balance sheet -- the current ratio is more than 3-to-1 and there’s no debt net of cash.

Management seems committed to increasing shareholder value. This could be accomplished through share repurchases, boosting the dividend or a takeover.  That last option made news earlier this month when the New York Post reported Foot Locker is seeking to sell itself. According to the story, Foot Locker has hired Lehman Brothers to advise it on a possible sale. Apollo Management LP is supposedly considering an offer of $29 a share, and billionaire Mike Ashley, owner of Sports Direct International in the UK, is reportedly interested.

Foot Locker, Apollo and Sports Direct refused comment, as would be expected. The stock rose to $22.71 the day the Post story ran, but has since fallen back.

I didn’t buy the stock anticipating a quick sale of the company. I think that’s possible. And that possibility along with the other options available to management due to the sterling balance sheet makes the long-term prospects for Foot Locker favorable.

The main risks with this stock pick involve the possibility of worsening economic conditions and declining consumer discretionary spending. I believe those would prove to be near-to-intermediate term events, yet I could always be wrong. So be sure to do your own due diligence before buying this or any stock.

UPDATE 11/6/07: More shares were bought today at $13.73. The average cost of this position is $18.93.

Comments

[hopton123]

I've looked at FL several times... I really liked the structural competitive landscape for FL. In the U.S. FL's competition is financially weak and in the EU FL dominates. Plus FL is rationalizing stores and focusing on margins, LT positive for a retailer.

Value Insight had a good review. http://retail.seekingalpha.com/article/7785

[2L]

"there’s no debt net of cash" ----

hmm, you don't consider the PV of the operating leases as 'debt?' even FL itself considers them debt, since "these commitments are the primary financing vehicle for the Company."

[John]

hopton123: Thanks for the link.

2L: See this link from Foot Locker's first quarter results, the last reported:

http://www.marketwatch.com/news/story/foot-locker-inc-reports-first/story.aspx?guid=%7B56F0D7D7-710F-4A49-8F95-0E5D429A6DBE%7D

Financial Position
The Company continued to strengthen its financial position while also redeploying its strong cash flow with a goal of enhancing shareholder value. At the end of the first quarter, the Company's cash position, net of debt, was $183 million, an $85 million improvement from the same time last year. The Company's cash and short-term investments totaled $418 million, while its total debt was $235 million. During the first quarter, the Company paid out $19 million in shareholder dividends and repurchased 1.2 million shares of its common stock for $26 million.

[F]

According to FL's most recent 10-K, the present value of its operating lease commitments is $2.07bn. Total net debt after taking into consideration of operating leases were $1.673bn and $1.833bn, respectively, as of the end of fiscal 2005 and 2006.

It's important to consider these operating leases (which are often used to finance real estate) when analyzing retailers because they do represent a fixed charge, just like interest expense. For your reference, Value Line reported that Foot Locker's fiscal 2006 annual rentals relating to operating leases is $486MM.

[Pradeep]

I dont think FL is cheap...for a slow grower...i think earnings yield of 20% is cheap....I like stuff at 50% off...so under 14$ would be a buy...no surprise that it's full price is 28$..and its high is 29$.

As a side - Debs Shops got bought out by LBO at 10% earnings yield...it too is a slow grower.

[2L]

You're just completely missing what "F" and I are talking about FL's effective debt that you should be taking into account when calculating net debt (& TEV). I don't understand how you could have just blown by page 15 of the 10-K:

http://www.sec.gov/Archives/edgar/data/850209/000120677407000876/footlocker_10k.htm
"Debt Capitalization and Equity

For purposes of calculating debt to total capitalization, the Company includes the present value of operating lease commitments. ******These commitments are the primary financing vehicle for the Company.******"

To get out of the operating leases, FL would effectively have to pay the PV of them. This is a real fixed cost that needs to be paid, and it needs to be added to FL's TEV.

Please just read pages 15-17 of the 10-K.

The truest debt figure for FL is the $2.9b listed under "contractual cash obligations" together with the $1.9b under "other commercial obligations" on page 17. After subtracting the $470mm in cash, this leaves net debt at ohhhh, $4.4 BILLION . . .

I'd love to hear what your thoughts are on FL's "strong balance sheet"

[John]

2L: I don't see the leases as a problem, though I may be wrong in taking that view. Foot Locker generates cash, has increased its dividend, and bought back shares. And the management is shareholder friendly.