On Thursday, Telsey Advisory Group revised its rating for Foot Locker (NYSE:FL), shifting from Outperform to Market Perform, alongside a reduction in the price target to $28 from $38. The downgrade reflects concerns over an anticipated slower recovery in operating margins due to higher than expected selling, general, and administrative (SG&A) expenses in 2024.
Foot Locker's guidance suggested only a modest operating margin expansion of 10 to 50 basis points year-over-year to 2.8%-3.2% in 2024. This projection falls short of expectations, despite the company's better-than-anticipated comparable sales and gross margin guidance.
The retailer's higher SG&A spending is viewed as a new baseline, influenced by normalized incentive compensation and increased investments in store refurbishments, marketing, and technology, which are expected to continue into 2025.
To achieve the targeted operating margins of 8.5%-9.0%, Foot Locker would need to accelerate sales growth to 5%-6%, a rate not seen since 2016, barring the exceptional pandemic-driven boom in 2021. The market remains skeptical about the company's ability to significantly increase growth and gain market share in the near term without further evidence.
Despite these concerns, Foot Locker's fourth quarter of 2023 showed signs of sales stabilization, with some products and brands gaining traction and improved customer conversion rates. Additionally, the company is set to see an increase in product allocation from its largest vendor, Nike (NYSE:NKE), starting in the fourth quarter of 2024, after a period of reduction.
The revised 12-month price target is based on applying an 11 times price-to-earnings (P/E) multiple, lowered from 13 times, to the 2025 earnings per share (EPS) estimate of $2.55, which has been adjusted down from $2.95. This P/E multiple aligns more closely with Foot Locker's ten-year average.
The firm's stance will remain neutral until there is clearer evidence that Foot Locker can achieve a stronger recovery in operating margin and EPS in 2025 and beyond.
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