Why Foot Locker Is an Undervalued Dividend-Paying Blue Chip

When it comes to building a portfolio, we believe that investors should focus their capital on purchasing shares of the best companies. Blue chips are those companies that are industry leaders, setting themselves apart from the competition. One name we think should be considered by both value and income investors alike is Foot Locker, Inc. . Not only do we believe that Foot Locker is a blue-chip company, but it is also our favorite company in the fashion and clothing industry. Something that should never go out of fashion is buying stocks with excellent potential for future gains. So, let's examine why Foot Locker is one stock worth buying at the current price. Business Overview and Recent Earnings Results Foot Locker is a leading retailer that focuses its business on athletic footwear and apparel. The company sells its products through several different stores, such as Foot Locker, Lady Foot Locker, Kids Foot Locker and Champs Sports. In total, Foot Locker has nearly 3,000 store locations. The $4.8 billion company has annual revenues of $7.6 billion. Foot Locker reported earnings results for the second quarter on Aug. 20. Revenue grew 9.5% to $2.3 billion. Adjusted earnings per share of $2.21 compared extremely favorably to adjusted EPS of $0.71 a year earlier. the company topped expectations on both the top- and bottom-line. Comparable same-store sales were higher by nearly 7%. With strength like this, it's not surprising that gains were seen nearly everywhere. Kids Foot Locker and Champs Sports both produced double-digit growth rates, which were made even more impressive as these channels had double-digit growth in the same period a year ago. Footwear and apparel also stood out in performance. Results were going up against a difficult comparison as well. For example, the second quarter of 2020 was the best year-over-year revenue growth that Foot Locker saw last year. Revenue grew more than 28% from the second quarter of 2019. Adjusted EPS was higher by 235%. The company repurchased just $8 million worth of stock during the fiscal second quarter, but ended the quarter with a net cash position of nearly $2 billion. Amazingly, this cash balance is almost a third of its market capitalization. Foot Locker is expected to post $7.15 of adjusted EPS in full-year 2021, which would be a 154% increase compared to 2020 and a 45% improvement from 2019 if achieved. Growth Prospects & Competitive Advantages Foot Locker has made investing in its digital capabilities a priority. This has paid off as the company had a digital penetration rate of just over 20% in the most recent quarter. This normalized from last year's figure, but remains much higher than levels seen in pre-pandemic 2019. Foot Locker is connecting with potential customers through its membership program, called FLX. The company counted more than 25 million members at the end of the quarter, a 25% increase on a sequential basis. This massive growth in just three months is very impressive and gives Foot Locker a wide pool of potential first-time and repeat customers. The company said that members tend to spend more than non-members, to the tune of 75% more in the second quarter. These members tend to shop more frequently and have higher average tickets. The company has been aggressive at transforming and updating its stores to be more appealing to consumers. Foot Locker is in the process of winding down its Footaction business and transforming these locations into Foot Locker stores. 50 such conversions have already taken place and the rest should be concluded by the end of next year. The company has closed 130 Footaction stores as many of these locations are close to another Foot Locker store. This likely means that transactions will simply move locations. At the same time, Foot Locker is expanding its presence in certain areas. For example, the company just launched its website in South Korea and opened two new stores in the market. In addition, Foot Locker entered into a licensing agreement with MAP Active, a top brand commerce and athletic retailer in Southeast Asia, that will grant the company access to the Indonesia market. Finally, Foot Locker augments its core business with strategic acquisitions. The company spent a combined $1.1 billion on two separate purchases during the quarter. First, the company added footwear and apparel retailer Eurostar, or WSS, for $750 million. The company has more than 90 off-mall locations in several states, including California and Texas, and had revenue of $425 million last year. Next, the company acquired atmos, a Japanese retailer that specializes in premium sneakers and apparel, for $360 million. Atmos had revenue of $175 million in 2020. This purchase improves Foot Locker's presence in Japan. Valuation & Expected Returns Foot Locker's EPS has a compound annual growth rate of just 4.6% over the last decade. However, this includes last year's Covid-19 impacted results. Looking at the prior 10-year period, EPS had a CAGR of 16.2%. Foot Locker reduced its share count by almost 4% annually over the last decade, which has provided a major tailwind to earnings growth. We forecast a more modest growth rate of 3% through 2026, which we feel takes into account the quality of the firm with the very high earnings base we are expecting this year. With the shares trading around $46, Foot Locker has a price-to-earnings ratio of just 6.4. We think that a valuation of 12 times earnings, near the long-term average, is appropriate for the stock. This implies a massive tailwind from multiple expansion. If the stock were to trade with our target multiple by 2026 then valuation would add 13.4% to total returns. Also factoring into total returns will be the company's dividend. Prior to last year, Foot Locker has nearly a decade of dividend growth. However, the company was forced to suspend and then cut its dividend during the worst part of the pandemic. Prior to last year, the dividend had a 10-year CAGR of nearly 10%. Though the dividend is not yet back to pre-pandemic levels, Foot Locker has raised its dividend twice in 2021. We believe that the dividend will surpass its previous mark in the very near future. The shares yield 2.6% today, twice that of the S&P 500 index. In total, we expect annual returns of 19% per year through 2026. Our projected return stems from a 3% earnings growth rate, 2.6% starting dividend yield and a low double-digit tailwind from multiple expansion. With a leadership position in its industry, several growth prospects that should enable future gains and in our view, a seriously mispriced valuation, we believe that Foot Locker is poised to deliver outsized returns over the next five years. Given this, we rate shares of the company as a strong buy.

Why Foot Locker Is an Undervalued Dividend-Paying Blue Chip

Something that should never go out of fashion is buying stocks with excellent potential for future gains.

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