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Morgan Stanley upgrades Foot Locker to overweight

Foot Locker’s recent weakness amid concerns about market share loss has created “an excellent opportunity to buy,” Morgan Stanley analyst Jay Sole wrote in a note, upgrading shares to overweight from equal weight.

Shares in Foot Locker have been selling off due to concerns that online retailers are winning market share. However, Morgan Stanley believe Foot Locker can defend its position despite concerns about share loss to Amazon and brands’ own websites.

Amazon and Foot Locker target different segments of the market and brands still want a strong, premium mall presence which Foot Locker provides. Morgan Stanley have a price target of $65 on the stock.

Investment Rationale

We maintain our Buy recommendation with a price target on Foot Locker of $75 per share.

Shares of Foot Locker have fallen after analysts started to worry that the Company wouldn’t be able to reach its goals for 2017. I believe this negativity is more than being priced in, and the shares are now trading at attractive levels. The shares are trading on a P/E of 10.5x compared to their historical average of 15x. Based on 2018E earnings of $5.10 and assuming that the Company will get back on track, we expect the shares to trade at $75 per share.

Shares of Foot Locker have fallen after analysts started to worry that the Company wouldn’t be able to reach its goals for 2017 for the following reasons:

  • Sales of Nike footwear, which account for more than 66% of Foot Locker’s revenue, have softened after strong 5-year run
  • Nike inventory is running high
  • Management are also seeing weak results in direct-to-consumer business (which account for 13% of revenues), with the result of the Company having been forced to cut prices on web site
  • Prospects for weaker near-term sales, operating margins, EPS growth warrant below-average multiples

However, after a management telecom by analysts, the outlook was not as bleak as one interpreted from the results. Management’s tone was clear confidence that the low-single-digit run-rate is more transient driven by product flow timing with the combination of innovation, greater depth in key styles, and experience rather than “cycle” driving a return to mid-single-digit top-line growth citing no changes to the medium (2H17) or long-term (FY18+) outlook.

Management have also said that if they do continue to see weakness in their top line revenue, they will revert to cost saving measures in order to maintain margins. Although this is not an idea scenario, one must also look at the level we are trading at today.

We remain confident in Foot Locker and see the current price as a good entry point.

Conclusion

We are comfortable holding Foot Locker as part of a well-diversified portfolio. It is well positioned to continue to benefit from further growth, as global economic growth continues to remain supportive.

Our optimism at this stage is expecting that Nike’s product pipeline will improve as the year progresses and knowing that Foot Locker has a long track record of impressively managing expenses helps.

About the Company

Foot Locker is a leading global athletic footwear and apparel retailer, which caters to the sneaker enthusiast. Its stores offer the latest in athletically-inspired footwear and apparel, manufactured primarily by the leading athletic brands. Foot Locker provides the best selection of premium products for a wide variety of activities, including basketball, running, and training.