What The Footlocker (NYSE:FL) Downgrade Means For You (Buy)

A Downgrade, Oh No!

This morning Footlocker (NYSE:FL) received what all publicly-traded companies fear, the dreaded analysts-downgrade. While not good news for the company, it, like everything else in the market, needs to be examined before a final judgment can be made. After all, one man’s junk is another treasure and a downgrade from strong-buy to buy doesn't mean the same thing as one from neutral to sell. In the end, what matters most is why Footlocker got downgraded, what the downgrade means for the fundamental business, and how it affects the company’s outlook for earnings.

What the analyst at B Riley FBR said was this, Footlocker is implementing more promotional activity than its competitors, rating a downgrade to neutral from buy. The takeaway for investors is that revenue and/or earnings may be negatively impacted by ad-spend, mark-downs, deals, or a combination of all three. In the near-term that might be bad, Footlocker may miss its consensus targets, but in the long-term, it is great news indeed. The pandemic has shaken up the retail world and Footlocker is fighting come out on top.

The analyst community was already largely neutral on this retail stock so it is no surprise it got a downgrade today. The bias within the community, however, is bullish, so take that with a grain of salt. While the near-term outlook is iffy, there is a large decline in revenue and earnings expected in the 2^nd quarter, the long-term projections are good. After the second-quarter dip, revenue and earnings are both expected to creep higher on a sequential basis through the end of 2021 and generate ample cash flow.

The Dividend, It Could Be A Major Catalyst

Footlocker made the decision to suspend its cash dividend at the beginning of the 2^nd quarter. The takeaways for investors is this; the move was defensive, they didn’t have to do it, and there is a high expectation it will be reinstated in the not-too-distant future.

In terms of the balance sheet, the balance sheet is rock-solid with very low levels of debt and a large cash position. The decision to suspend the payment is meant to preserve cash while the economic rebound unfolds and the rebound is unfolding. Considering May’s retail sales figures came in so strong I expect to see Footlocker post robust figures when it next reports earnings.

In this light, there are two catalysts investors should consider. The first is tied to the rebound. Assuming the company is able to rebound and preserve its cash positions, there is a chance Footlocker will attempt to make up all or a portion of lost distributions. That would result in a large, one-time payment later this year or early next.

The second is the timing of when and how the dividend will be reinstated. Based on next year’s outlook for earnings, the company could reinstate the distribution at the previous rate in the first calendar quarter with no trouble. At today’s prices that is a yield close to 5.75% and more than enough to spark a major rally in the stock. If the rebound is strong enough, the dividend may be reinstated sooner than expected.

The Analysts Are Neutral, But …

The analysts are neutral on this stock but that doesn’t mean they don’t see gains ahead. The consensus price target for Footlocker is just over $34 which implies about 25% upside for shareholders. Looking at the chart, $34 represents the most recent price peak and the post-pandemic high so it is within easy reach of the market. Based on the candle set-up, that high could be retested or exceeded very soon. The candles are showing support at the $27.50 level that, if confirmed, would in turn confirm a bullish reversal of price action. Projecting the magnitude of the reversal pattern, about $10, the next price peak could be closer to $37.50.

The risk is in the EMA. Price action is still below the EMA and, with no major catalyst at hand, could drift even lower. If support at the $27.50 fails to hold investors will get a chance to buy into this rebound-play at a lower price point, possibly in the $22.50 to $25.00 region.

The bottom line, Footlocker is well-capitalized, has a positive outlook for revenue and EPS, and comes with a major catalyst primed and ready to fire. If Footlocker’s price does move lower from here, and the economic rebound doesn't stall, the risk/reward ratio will only become more attractive.