A Quality Exec Comp Plan Lowers The Risk Of Investing In Foot Locker

Three new stocks make July’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of July 15, 2021.

Recap From June’s Picks

The Exec Comp Aligned with ROIC Model Portfolio (+3.8%) outperformed the S&P 500 (+3.2%) from June 16, 2021 through July 13, 2021. The best performing stock in the portfolio was up 12%. Overall, seven out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P 500 from June 16, 2021 through July 13, 2021.

This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating and align executive compensation with improving ROIC. I think this combination provides a uniquely well-screened list of long ideas because return on invested capital (ROIC) is the primary driver of shareholder value creation.

New Stock Feature for July: Foot Locker Inc.
FL

Foot Locker Inc. (FL) is the featured stock in July’s Exec Comp Aligned with ROIC Model Portfolio.

Foot Locker has grown revenue by 4% compounded annually and net operating profit after tax (NOPAT) by 5% compounded annually over the past ten years, per Figure 1. NOPAT margin improved from 5% in fiscal 2011 to 8% over the trailing-twelve-month period (TTM). Figure 1 also shows Foot Locker’s revenue and profitability have rebounded strongly in the TTM period after COVID-19 impact in fiscal 2021.

Figure 1: Foot Locker’s NOPAT Growth: Fiscal 2011 – TTM

ROIC-Based Pay Properly Incentivizes Executives

Foot Locker’s executive compensation plan aligns executives’ interests with shareholder’s interests by tying its long-term equity-based awards to a two-year ROIC performance goal.

Foot Locker’s inclusion of ROIC as an executive compensation performance goal has helped drive shareholder value creation and economic earnings, per Figure 2. Foot Locker’s ROIC improved from 5% in fiscal 2011 to 10% TTM while its economic earnings grew from -$17 million to $357 million over the same time.

Figure 2: Foot Locker’s Economic Earnings: Fiscal 2011 – TTM

FL Is Undervalued

At its current price of $56/share, FL has a price-to-economic book value (PEBV) ratio of 0.4. This ratio means the market expects Foot Locker’s NOPAT to permanently decline by 60%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 3% compounded annually over the past two decades.

Even if Foot Locker’s NOPAT margin remains at 5% (equal to fiscal 2021, lowest margin since fiscal 2011) and the firm grows NOPAT by just 2% compounded annually over the next 10 years, the stock is worth $88/share today – a 57% upside. See the math behind this reverse DCF scenario. For reference, Foot Locker has grown NOPAT by 5% compounded annually over the past decade. Should the firm grow NOPAT more in line with historical growth rates, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Foot Locker’s 10-K and 10-Qs:

Income Statement: I made $461 million in adjustments, with a net effect of removing $63 million in non-operating expenses (1% of revenue).You can see all the adjustments made to Foot Locker’s income statement here.

Balance Sheet: I made $3.9 billion in adjustments to calculate invested capital with a net increase of $398 million. One of the largest adjustments was $1.2 billion (22% of reported net assets) in asset write downs. You can see all the adjustments made to Foot Locker’s balance sheet here.

Valuation: I made $5.2 billion in adjustments with a net effect of decreasing shareholder value by $1.5 billion. Apart from total debt, the most notable adjustment to shareholder value was $1.9 billion in excess cash. This adjustment represents 33% of Foot Locker’s market cap. See all adjustments to Foot Locker’s valuation here.

Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

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