Foot Locker’s Quarter Sends Doubters Running

Key Points

• Foot Locker's first quarter shows improvement in its financial efficiency despite slowing sales.
• Management remains optimistic about Foot Locker's "Lace Up" initiative, which is already showing positive results.
• With an industry breakout backed by a more confident consumer, the odds of Foot Locker seeing higher prices are increasing.

After reporting its first quarter 2024 financial results, shares of Foot Locker Inc. NYSE: FL jumped by as much as 40% as markets reacted to what could be the retail sector’s latest turnaround story. Now that the stock is consolidating to the end of the week, investors can use this breather to hop on a new thesis for Foot Locker stock.

This thesis centers on management’s plan to turn things around and deliver even better bottom-line results, among many other points. After a challenging past couple of years, the U.S. consumer may finally be on a comeback, which is why bulls had no problem ripping up Foot Locker stock after earnings.

But before investors dig into the company's results and what they mean for the stock's future, it would be helpful to understand where the economy could be headed, particularly the trends affecting consumer discretionary stocks. Even if Foot Locker does well, it still has to overcome potentially negative sentiment around its peers.

Financial Strength of Foot Locker Underpins Analyst Optimism

After contracting for four months straight, U.S. consumer sentiment readings have finally expanded, crystalizing what could be the bottoming for retail stocks like Foot Locker. In this fashion, investors can have a couple of catalysts to lean on.

First, the ISM manufacturing PMI index showed three consecutive months of expansion for the apparel industry, increasing the upside-tail risk for stocks inside it to report better-than-expected earnings or at least optimistic outlooks for the rest of the year.

Sentiment and business activity may have been aided by the prospect of interest rate cuts later this year, which, according to the CME’s FedWatch tool, could be here as soon as September 2024.

Airline stocks could act as a proxy for future consumption, as analysts recently upgraded United Airlines Holdings Inc. NASDAQ: UAL after the Transportation Security Administration (TSA) reported a new record 2.9 million passengers in a single day.

What’s the next most common spending item for consumers after travel? That’s right, apparel. Foot Locker investors know this, and analysts weren’t afraid to take this view.

Wall Street wants to see up to 43.8% earnings per share (EPS) growth for Foot Locker in the next 12 months, beating those at peers like Nike Inc. NYSE: NKE with its 5.9% growth projections for the year.

Why would analysts stick their necks out in such a bullish projection for Foot Locker? Here’s where the company’s financials come into play.

A Mixed First Quarter for Foot Locker With a Deep Message

While comparable sales, the retail sector's primary key performance indicator (KPI), declined by 1.8% over the year, other metrics indicate the company's resilient efficiency.

Accounts payable in the company’s cash flow statement rose by roughly $170 million, typically meaning the company is looking to increase inventory while delaying payment to its suppliers.

That can be taken as a good sign for higher demand, where analyst projections come to fruition. Now that the stock has traded down to 73% of its 52-week high, despite its recent rally, valuations have become more critical.

Foot Locker stock trades at a roughly 20% discount to its book value, as suggested by its 0.8x price-to-book (P/B) ratio. Compared to the rest of the shoe store industry, this represents a 50% discount to its 1.7x average P/B valuation, and that’s where investors can get a near-free ride.

However, there is no guarantee on Wall Street. Analysts are still undecided on whether management's plans to revamp operations will be successful. The company's operating cash flow of $58 million, compared to a negative $118 million last year, suggests these plans are facing challenges.

CEO Mary Dillon credits these changes to Foot Locker’s ‘Lace-Up’ plan, which consists of better expense timing, seen in the accounts payable change, and improved logistics and store efficiencies.

Analysts at Evercore seem to believe in this plan, as they slapped a $32 price target on Foot Locker. The stock must rally by an additional 25% from today’s prices to prove these projections right.

Even short sellers seem to be in sync with management, as Foot Locker’s short interest collapsed by 15% over the past month, giving way for bulls to take over. While there is still a long way to go, it seems Foot Locker is stepping on the right foot.