On Thursday, Morgan Stanley downgraded shares of Foot Locker (NYSE:FL) from Equalweight to Underweight, significantly reducing the price target to $18.00 from the previous $24.00. The firm's revised outlook is based on a more cautious forecast for the company's 2024 earnings per share (EPS), expecting it to fall well below both the company's guidance and the consensus estimate.
The downgrade was influenced by projections of a year-over-year decline in top-line growth and gross margin (GM) for the year 2024. Morgan Stanley anticipates a 2% decrease in yearly sales, which is more conservative than Foot Locker's own guidance of a 1% decrease to a 1% increase, and the roughly flat growth expected by the market. Additionally, the firm foresees a gross margin of 29.4%, below the guidance of 29.8-30.0% and the 29.8% market consensus.
For the second quarter, Morgan Stanley expects a larger downside in EPS than previously implied by guidance, forecasting a 18-cent loss compared to the 6 to 14 cents loss suggested by the company and the 8-cent loss anticipated by the market. This expectation is primarily due to lower sales growth projections.
The revision also includes a downward adjustment to the medium-term (M-T) operating forecast, starting from a lower base year in 2024. The forecast through 2028 now assumes flat average annual top-line growth, compared to the previously expected 1% increase per year.
The operating margin (OM) expectations remain largely unchanged at an average of around 3% through 2028. These changes result in a medium-term EPS estimate that is approximately 30% below the average market consensus.
The new price target of $18 is also the outcome of updated discounted cash flow (DCF) assumptions, including a reduction in the terminal growth rate to -1% and a terminal margin of 3.5%, compared to the prior -1% growth rate and 5% margin.
Additionally, the weighted average cost of capital (WACC) has been slightly adjusted to 9.3% from the previous 9.4%. These revised financial metrics contribute to the lower valuation of Foot Locker's stock.
In other recent news, Foot Locker's first-quarter results for 2024 have been in line with market expectations, with an earnings per share (EPS) beat, despite a 1.8% decrease in comparable sales. The company's Foot Locker and Kids Foot Locker segments have shown positive comparable store sales, and the company's full-year non-GAAP EPS guidance remains at $1.50 to $1.70.
Analysts from Barclays Capital Inc., Evercore ISI, Jefferies, and Telsey Advisory Group have adjusted their outlook on the company, with Barclays and Telsey Advisory Group raising their price targets to $27.
Analysts have noted that the company's strategic initiatives, such as store remodels, a new mobile app, and the launch of the FLX Rewards program, are expected to drive long-term profitability. Strategic partnerships, particularly with Nike (NYSE:NKE), are also expected to boost traffic and potentially lead to upward revisions in profitability estimates.
However, analysts have also expressed caution due to potential cost increases in the subsequent quarter due to deferred selling, general, and administrative expenses.
Foot Locker's margins are also expected to be lower compared to its peers in the near future, and EBIT margins are anticipated to stay well below levels seen in 2019. Despite these challenges, the company's strategic value as a potential acquisition target is underscored, given its scale and authority in the athletic retail sector.
InvestingPro Insights
In light of Morgan Stanley's downgraded outlook for Foot Locker, real-time data from InvestingPro provides additional context. With a market capitalization of $2.51 billion, Foot Locker is trading at a high EBIT valuation multiple, suggesting expectations of future earnings growth. Despite a recent negative revenue growth of -4.65% over the last twelve months as of Q1 2023, analysts predict the company will be profitable this year, which may offer some reassurance to investors considering the stock's potential for recovery.
InvestingPro Tips indicate that while Foot Locker has maintained dividend payments for 21 consecutive years, it is currently not paying a dividend to shareholders. This could reflect a strategic shift in capital allocation or a temporary suspension due to the financial forecasts. Additionally, the company's liquid assets exceed its short-term obligations, providing a degree of financial stability in a challenging retail environment.
For those looking to delve deeper into Foot Locker's financial health and future prospects, InvestingPro offers additional tips. There are 15 more tips available on InvestingPro's platform that could help investors make a more informed decision. Interested readers can use the coupon code PRONEWS24 to get up to 10% off a yearly Pro and a yearly or biyearly Pro+ subscription, gaining access to a wealth of financial analysis and expert insights.
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