Shares of Foot Locker (FL) opened trading down 11% Friday after reporting second quarter earnings results that did not deliver. The stock continued to fall throughout the morning. The results disappointed relative to estimates, and included a marked drop in earnings. To me, the dynamics within retail right now really favor the names that have a more diversified spread of offerings. Target (TGT) did well, as they have scale and a broad product lineup that brings in many different types of consumers. In a world where retail is still in a state of evolution, it's those names that I feel will do well.
Ironically, comp store sales did increase 0.8% in the second quarter. The growth simply didn't live up to expectations of 3.2%. Moreover, total sales actually stagnated year over year to $1.77 billion vs. $1.78 billion. The anemic overall story is spooky to investors in a time when retailers are either thriving or dying. Operating income took a real hit in the quarter, declining by 27.6% to $81 million. Net income declined 31.8% to $60 million. That hurts. Hurts a lot. That income broke down to $0.55 per diluted share, a 26.6% decline.
For the first half of the year, overall sales are up slightly. That growth isn't really translating to shareholder value however, as the costs associated with those sales have eaten into operating incomes. Through the first six months of the year, income from operations is down 8%. Net income is down a comparable 8.3% to $232 million. To a degree, Foot Locker has been implementing the same earnings trick that we've seen so many names initiate this year, namely stock buybacks. Share counts were down 5% in the second quarter relative to the same period a year ago.
For Foot Locker, the story is very much a question of whether the second half of the year can be better than the first. Q1 and Q2 were not inspiring. The business is sound from a balance sheet standpoint. Cash is strong, and long term debt remains low. Total shareholder's equity is actually up year over year to $2.5 billion. The company has a good foundation to stand on from that perspective, it's simply a matter of how long they can ride it before things need to improve on the income statement.
I do believe that the third quarter will be stronger as momentum from back to school shopping kicks in. Moreover, management iterated that second quarter performance did improve as the months progressed. That said, I'm skeptical of retailers that are so invested in a singular product.
Foot Locker by all accounts is a middle man for the shoe industry. I like retailers that have many, many product offerings, thus holding broader appeal to consumers. In this day and age, you're more likely to go to the store that holds all of the things you need to buy, rather than making one stop for shoes.
We've seen some strength in retail from Walmart (WMT) , Target (TGT) , and Dick's Sporting Goods (DKS) . By some logic, that could imply consumer strength for the second half that Foot Locker might benefit from right? I go back to my view before. The retailers that seem to be succeeding are the ones with a more diverse lineup of offerings. Walmart doesn't specialize in one product. They offer everything. Target is no different. Dick's Sporting Goods is on the line. They are certainly a specialty retailer, but they gain an advantage from their scale and weakness of competition within the sports/outdoors segment. Foot Locker on the other hand is competing with all three of them, as well as any other retailer with shoes.
As names like Nike (NKE) continue pushing their own direct to consumer initiatives, there is a danger that they might get more comfortable "cutting out the middle man" down the road. Balancing that fear, with the cheap valuation, strong dividend, and assets, I rate FL a "Hold". The company has a five year trend of revenue growth, only recently having headaches with earnings. There was a solid business here at one point. It might be worth waiting to see if it's still there.