Foot Locker’s financial troubles are much worse than feared, leading us to reevaluate the stock

Foot Locker (FL) reported awful fiscal 2023 second-quarter results and guidance before the opening bell Wednesday, prompting a major change in the way we look at this stock. Total revenue fell 10% year-over-year to $1.86 billion, missing the Refinitiv compiled consensus estimate for $1.88 billion. Adjusted earnings-per-share plummeted 96% to 4 cents. However, that EPS number matched analyst estimates, according to Refinitiv. Worse yet, the company announced a pause in dividend payments, a sign that management doesn’t see things improving anytime soon. Shares of Foot Locker plunged more than 30% in Wednesday’s trading. The stock has now declined nearly 60% year to date compared to the S & P 500’s more than 15% advance in 2023. FL .SPX YTD mountain Foot Locker vs. S & P 500 year to date Bottom line As noted during Monday’s Homestretch , we thought this would be a horrible quarter from Foot Locker. In hindsight, horrible wasn’t a harsh enough word. The company reported one of the worst quarters we have ever seen. We have no choice but to move to the sidelines, downgrading the stock to our 4 rating and removing our price target. The Club’s 4 rating is our way of serving notice that no action will be taken on the stock until more information becomes available. A major pillar of our investment thesis in Foot Locker was faith that CEO Mary Dillon would be able to work the same type of magic at Foot Locker that she used to turn around Ulta Beauty (UTLA). Make no mistake that when Dillon came out of retirement last year to lead Foot Locker she was inheriting a herculean task. Jim Cramer said on Wednesday that he respects Dillon and always thought a turnaround of Foot Locker would take time. However, it’s taking much more time and is more challenging than originally anticipated. While eking out adjusted earnings and same-store sales for the quarter that matched expectations, that was little comfort seeing as earnings were down 96% versus the year-ago period and same-store sales dropped 9.4%. Management cited a weak consumer, the repositioning of its Champs Sports brand, and a changing vendor mix. We know the company has been trying to reduce its reliance on Nike (NKE), which has its own brick-and-mortar retail and online stores, while also closing underperforming mall-based stores. Compounding the fact that even the numbers that matched estimates were soft, both gross and operating income came up short. Those metrics missed estimates despite lower-than-expected Selling, General & Administrative (SG & A) expenses. Topping it all off, the company will be suspending quarterly dividend payments after its previously announced 40-cents-per-share quarterly payout goes to shareholders on Oct. 27. On the post-earnings call, Dillon said that the weakness seen in the second quarter continued into August. “Looking back to March, when we outlined our lease plan and our longer-term targets, we were coming off a strong holiday and had not yet seen the full weight of the macro environment on our lower-income consumer. This became much more evident through the second quarter, including a weaker start to back-to-school. The store traffic and conversion challenges, we began to see in late Q1 persisted through the second quarter as our customers remained cautious with their discretionary dollars. As a result, we’ve promoted more heavily than initially planned to better compete for a share of our customers’ wallets and manage our inventory levels.” We know the lower-income consumer has come under immense pressure due to high inflation. However, recent evidence also showed that consumers in general are more focused on discretionary services than they are goods. As a result, inventory remains way too high at Foot Locker, and in a worst-case scenario –management may need to tap into its credit lines. As of the end of Q2, there was only $180 million in cash and cash equivalents on the balance sheet. The operating cash burn increased to $184 million from the quarterly rate of $118 million in Q1. Guidance On the call, Dillon said the team was lowering full-year forward guidance following a weaker-than-expected first half of the year. Management now expects fiscal 2023 sales to be down 8% to 9% from the previous range of a 6.5% to 8% decline. Analysts had been modeling an 8% full-year decline. Adjusted full-year EPS guidance was also revised lower to a range of $1.30 to $1.50. That’s down from $2 to $2.25 previously and below the $2 that had been expected. For the full year, same-store sales are now forecast to be down a greater-than-expected 9% to 10%. The previous range had called for a 7.5% to 9% decline. Foot Locker’s gross margin was lowered to 27.8% to 28%. That’s down from the previous range of 28.6% to 28.8% and below the 29.1% estimate. SG & A expenses as a percentage of revenue are now expected to be in a range of 22.7% to 22.9%, down from 22.4% to 22.6% previously. Quarterly commentary As we can see on the earnings table, there’s little positive in Foot Locker’s second-quarter result. Sure, SG & A expenses of $442 million came in better (meaning lower) than expectations, and so did the cost of sales at $1.34 billion. But neither was low enough to offset the sales miss. Under the Sales by Geography line item, North America dropped 13.4% in Q2 to $1.29 billion, EMEA (Europe, Middle East, and Africa) edged down 0.2% and the Asia Pacific region declined 2%. Looking at the Q2 product category comps in percentage terms, footwear was down high-single digits, apparel was down in the mid-teens, and accessories were down by low-double digits. Overall same-store sales, while in line, were dragged down by Champs Sports in North America, which saw a 25.3% decline. (Jim Cramer’s Charitable Trust is long FL. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.