Foot Locker's growth strategy through acquisitions and international expansion

Foot Locker Financial Analysis

Company Evaluation

Originally founded by Woolworth & Company chain in 1974,-Foot Locker is best known as being one of the highest performing subsidiaries of the Venator Group, the name the Woolworth's chain in 1998. As Woolworth's wanted to concentrate more on specialty retailing, which had significantly greater gross margins, the creation of the Venator Group made this strategy more achievable. In 1982 and 1987, Venator launched Lady Footlocker and Kids Footlocker. Based on the success of the Foot Locker chain, the company in 1993 completely redefined their business model to concentrate on specialty apparel and shoes stores. As a result, Venator Group closed 1,400 stores and changed its name to Foot Locker after the divesture.

The Venator Group chose to launch their first step in the Puente Hills Mall in Orange County, California as a test market in 1974. Within the next fi8ve years, 133 stores were added to the chain, and in 1982 Lady Foot Locker was created. The company experienced significant growth throughout the late 1980s, adding up to 867-Foot Locker stores in the U.S. And 244 lady Foot Locker stores as well, Also in 1987 the company opened up a Lady Foot Locker in Germany, marking the company's first expansion into Europe. Foot Locker also acquired Champs Sports and Robby's Sports in 1988. These acquisitions set the stage for the company's growth in Germany and new introduction of the chain to Australia. In 1991 the company acquired Freedom Sports to continue to bild out their retaiol chain in Australia, followed by the acquisition of Eastbay, footwear, equipment and apparel seller in the U.S. In 1998 the company continued its acquisition strategy with the acquisition of 94 Athletic Fitters stores and converted them to the classic Foot Locker retail and merchandising format. In 1999 the company launching footlocker.com quickly realized sales online and this has since grown into an essential part of the company's multichannel strategy.

As the series of acquisitions were successful and the demand in Europe continued to grow significantly, Foot Locker opened its own distribution center in the Netherlands. Acquisitions continued with the purchase in 2004 of the Footaction chain of retailers in the U.S., with a total of 350 locations acquired during this specific purchase. To further expand into Ireland, Foot Locker chose to acquire 11 additional Champion Sports Group stores throughout that nation. During 2004 the company focused on the development of trading agreements in the Middle East, a market that had yet to be developed by the company to this point in their history. Foot Locker invested in a 10-year development agreement with Alshaya Trading Company to launch 75 stores throughout the Middle Eastern nations served through the partnership. Through 2006 the company continued to growth through acquisitions and also with a stronger focus on retail operations, having completed 600 real estate projects in that year, including the opening of 119 new stores and investing in the remodeling of 316 stores. Using financial performance metrics, the company also chose to close 100 under-performing stores as well. During 2007 the company turned its attention to acquiring key parts of their value chain by attempting to purchase Genesco, North American wholesale marketers of footwear, headwear and accessories. Foot Locker offered $46 per share, an offer rejected by Genesco management. A follow-on offer of $51/share was made and this offer was also rejected.

As of April 2008,-Foot Locker has 3,000 stores in the U.S. alone and is one of the largest retailers globally. With over 21,000 shoe stores in the U.S. alone however, Foot Locker appears to have over-built its retail strategy. Further, this retail strategy is concentrated on malls and other traditional high retail traffic locations. The shift in athletic and casual shoe purchasing is increasingly outside of malls in specialty locations, a factor making it more difficult for Foot Locker to react to the market. This market dynamic is also the catalyst for the price competition the chain is experiencing, with competition from the low end of discount sports stores and mass merchandisers including Wal-Mart at the low-end and high-end discount store chains selling premium shoe brands.

Figure 1 graphically shows the challenge Foot Locker faces from the low-end and also from the high-end (Foot Locker, 2007)

Figure 1: Foot Locker is getting caught in the Middle

The two dominant competitors the company faces are Brown Shoe and Payless Shoe Source. Brown Shoe has made significant progress with their IMPACT initiative, which has focused on improving their supply chain, merchandising and allocation of inventory. The IMPACT initiative has earned the company 2.5% increase in gross margins since 2001. Secondly, Brown Shoes' inline initiative shoes.com has nearly doubled from 17.7M to $34.9M in 2007. The company does not specifically report these revenues however they were obtained through SEC filings and Hoovers records (Foot Locker, 2008). The other dominant competitor is Payless Shoe Source, which has successfully targeted the most prolific buying segment of shoe buyers, women who are between the ages of 18 and 49, and have incomes less than $75,000 per year. The company estimates this target demographic purchases one of three pairs from the company's stores further accentuating this segments' loyalty to the brand. Second, Payless has also been the most aggressive in terms of revamping and increasing the intensity of their advertising efforts to the 18 to 49 age segment with Hot Zones and the Fashion Lab. The company has also acquired a specialty marketing firm to assist with these store re-branding efforts, purchasing Collective Lab for $91M.

Financial Performance

Foot Locker faces greater competition and challenges to profitable growth than ever before, as their mainstream retailing strategy has isolated them from higher-growth market opportunities. Table 1, Foot Locker Ratio Analysis, illustrates the three-year trends of profitability ratios, liquidity indicators, and asset management ratios for the last three complete years of data. Starting with the poriftabili8ty ratios, ROE is sliding as the cost of revenues have grown while sales have stayed relatively constant, and the sales per square foot of their stores has not increased significantly in the last three years. As a result, ROE has slide to 10.76 for FY 20o7, sliding from 13.93 in 2005. EBITA as a percentage of Revenue has also slid significantly over the last three years as well. From 10.14 in 2005 to 9.67 in 2007, EBITA as a percentage of Revenue has also been impacted by increasing costs and a stagnant sales growth rate. The acquisitions that fueled profitability throughout the 1995-2001 timeframe has been replaced with significant stagnation of sales and lower sales in key U.S. markets. Of the eighteen ratios calculated, the Interest Coverage shows the company's heavy reliance on debt financing for acquisitions. Growing to 131.67 in FY2007 from 25.33 in 2005, this indicates heavy use of debt in the company and high interest changes on the financing used for acquisitions over the last decade. This is a danger sign for the company's debt rating and is a potential drain on liquidity.

Table 1 provides an overview of eighteen ratios illustrating the company's situation. Taken together the ratios point to the need for higher margin products quickly, including a re-aligning of the retail strategy to potential trim unprofitable stores and re-vamp stores designs to drive up more traffic and increase sales per square foot. The collection of metrics also point to a high level of churn in the shoe-buying public as well. Tables 2, 3 and 4 also provide financial analyses of Foot Locker including Income Statement, Balance Sheet, and Segment Analysis.

Strengths and Weaknesses Assessment of Foot Locker

From an analysis of the company's financial statements, this section defines their relative strengths and weaknesses. Table 2, Income Statement Analysis, Table 3,-Foot Locker Balance Sheet Analysis, and Table 4,-Foot Locker Business Segment Analysis are used as part of this analysis. The financial strengths of the company include stable revenue growth in a highly turbulent market while also consistently generating the majority of sales from their stores and also in the U.S., which are the fulfillment points in their supply chain the company is most effective at serving as shown by the stabilized operating expenses. Additional strengths of the company include their ability to manage to a low Days Sales Outstanding (DSO) as shown by the consistent level of Accounts Receivables, in addition to inventory management minimizing risk in this area. The company, while having much debt, is managing ti well over the three-year period.

The financial weaknesses of the company from this analysis highlight a financial structure however in need of an overhaul. With stagnating sales the operating expense per store is escalating and profits per square foot have been declining. This dynamic is also reflected in the increased store counts over the last three years with little increase in revenues and the declining ROA and ROE figures indicating a lower level of returns on assets and equity.

Opportunities for Future Growth and Expansion

First, Foot Locker needs to find strategies that will re-connect them with customers and increase sales. The stagnating sales the company is experiencing is eventually going to drag margins lower than 3%, where they are today. This has already been quite a slide for a company accustomed to 7% margins in a retail channel.

Foot Locker needs to follow the following series of four recommendations to address their financial challenges.

First, complete a thorough profitability analysis of all stores and trim back those that are below 70% of profitability objectives. The stores in low-traffic malls and centralized shopping locations need to be the first to go. This is essential to have additional funds for investing in marketing and the development of more efficient supply chain, order management and logistics systems. These store closures will have an immediate positive effect on ROA and ROE, in addition to creating more liquidity for paying down debt.

Second, Foot Locker must look recruit or acquire a branding firm to get their messaging, retail experience, and product selection to align with the most profitable segments of shoe purchasers. The company today is continuing to focus on the brands they carry as the brand support them need, rather than actively investing in their own brand. For Foot Locker to return to growth the company must re-invent the brand and inject it with greater energy and enthusiasm. The investments to date in the website have been minimal, leaving e-commerce to Brown Shoe Company to dominate. An entirely new marketing and product strategy is required to reconnect with the younger consumers, who purchase the majority of shoes.

Third, Foot Locker needs to realize that shoe vendor-owned stores are the greatest competitor, not other shoe distributors and aggregators and not rely on store build-out but process efficiency. In this respect the company is in danger of being disintermediated out of the channel it helped to create. This is the most strategic threat to the company. As vendor-owned stores had, between 2001 and 2007, a 9.5% compound annual growth rate in 2007 according to SEC filings (Foot Locker 2008), the same period Foot Locker experienced a -.2% growth rate, This further underscores the need for Foot Locker to look beyond the stores and move further into process efficiencies in their supply chain. The company therefore needs to embrace more an internal investment strategy to make their existing stores more agile in responding to unique requests, and also use these investments in supply chain process improvements to further drive greater performance of the stores in place after the 70% of those not performing are gone.

Fourth, the company must choose one of the top-line vendors are seek to create a highly integrated partnership with them to further support their turn-around efforts and gain additional brand equity from the vendor partner. Partnering specifically with Nike and positioning the chain as an opportunity for the vendor to gain greater independence from the pressure from mass merchandisers, Foot Locker needs to consider offering financial incentives to Nike in exchange for having their latest product introductions features exclusively in their stores. This could also be part of their marketing strategy to reinvigorate the chain as well. Foot Locker needs to realize that their consolidator strategy, so successful in the 1980s and 90s, is going to be increasingly difficult to continue and the selling off of previously acquired chains that contribute little margin also need to be jettisoned. This specific recommendation advocates looking to trim marginal acquisitions or those that aren't working at all right now and using those funds to further support the Nike partnership and its growth.

Appendices

Table 1 Foot Locker Ratio Analysis

Profitability Ratios

Return on Equity (%)

Return on Assets (%)

Return on Investment

Gross Margin

EBITDA of Revenue (%)

Operating Margin (%)

Pre-Tax Margin

Net Profit Margin (%)

Effective Tax Rate (%)

Liquidity Indicators

Quick Ratio

Current Ratio

Working Capital/Total Assets

Debt Management

Current Liabilities/Equity

Total Debt to Equity

Long-Term Debt to Assets

Asset Management

Revenues/Total Assets

Revenues/Working Capital

Interest Coverage

Table 2: Foot Locker Income Statement Analysis (000's)

Total Revenues

Cost of Revenues

Selling, General & Administrative

Depreciation & Amortization

Other Indirect Expenses

Total Indirect Expenses

Interest Expense

Other Income (Expense), net

Income Taxes

Discontinued Operations

Accounting Changes

Net Income

Common Dividends

Average Shares (Basic)

Average Shares (Diluted)

Outstanding Shares

Earnings per share - Cont Opers (Basic)

Earnings per share - Cont Opers (Diluted)

Earnings per share - Net Income (Basic)

Earnings per share - Net Income (Diluted)

Table 3: Foot Locker Balance Sheet Analysis (000's)

Cash & Cash Equivalents

Receivables

Inventories

Other Current Assets

Total Current Assets

Long-term Receivables

Investments and Advances

Land

Buildings

Gross Property, Plant & Equipment

Accumulated Depreciation & Amortization

Net Property & Equipment

Intangible Assets

Other Assets

Total Assets

Accounts Payable

Taxes Payable

Accrued Expenses

Current Portion of Long-term Debt

Deposits

Other Current Liabilities

Total Current Liabilities

Long-term Debt

Other Deferred Liabilities

Deferred Liabilities

Other Liabilities

Total Liabilities

Retained Earnings

Treasury Stock

Foreign Currency Translation

Other Stockholders' Equity

Stockholders' Equity

Total Liabilities & Stockholders' Equity

Table 4: Foot Locker Business Segment Analysis (000s)

Operating Income

Athletic Stores

Direct-to-Customers

Revenues

Athletic Stores

Direct-to-Customers

Geographic Analysis

Revenues

United States

International

TABLE 5: FOOTWEAR INDUSTRY ANALYSIS: Q1, 2008

Q1, 2008

Company Name Total Revenue Net Income EBITDA Total Assets Total Liabilities EBITDA of Revenue Gross Margin Profit Margin Return on Assets (ROA) Peer Avg: 1287413246.84 Peer Avg: 64555271.41 Peer Avg: 183906533.71 Peer Avg: 893507180.62 Peer Avg: 300675914.44 Peer Avg: 66.66 Peer Avg: 32.19 Peer Avg: 1.56 Peer Avg: (3.61) Bata India Ltd. $160,620,362 ($14,471,324) - $142,381,684 $85,343,202

10.16) Bata Pakistan Ltd. $38,296,541 $1,558,535 - $21,418,454 $12,252,274

9.56 Cole (Kenneth) Productions, Inc. $510,720,000 $7,083,000 $22,283,000 $354,537,000 $112,547,000

2.00 Czarina S.A. (Brazil) $8,340,755 ($4,790,969) - $7,991,141 $12,760,733

59.95) Foot Locker, Inc. $5,750,000,000 $251,000,000 $570,000,000 $3,249,000,000 $954,000,000

7.60 Pegasus International Holdings Ltd. $141,242,000 $2,467,000 $12,118,000 $146,089,000 $44,003,000

1.69 Rocky Brands Inc. $275,266,811 ($23,104,528) ($7,138,264) $216,724,527 $134,999,936

10.66) Skechers USA, Inc. $1,398,360,000 $75,686,000 $130,780,000 $827,977,000 $201,314,000

9.14 Timberland Co. (the) $1,436,451,000 $39,999,000 $90,197,000 $836,345,000 $259,185,000

4.78 Yue Yuen Industrial (Holdings) Ltd. $3,154,835,000 $310,126,000 $469,106,000 $3,132,608,000 $1,190,354,000

TABLE 6: FOOTWEAR INDUSTRY ANALYSIS: 2007

Company Name Total Revenue Net Income EBITDA Total Assets Total Liabilities EBITDA of Revenue Gross Margin Profit Margin Return on Assets (ROA) Peer Avg: 1874159562.20 Peer Avg: 70132694.40 Peer Avg: 161224347.20 Peer Avg: 1096916705.40 Peer Avg: 332409187.20 Peer Avg: 5.18 Peer Avg: 40.53 Peer Avg: 1.11 Peer Avg: 2.57 Bata India Ltd. -- -- - Bata Pakistan Ltd. -- -- - Cole (Kenneth) Productions, Inc. $510,720,000 $7,083,000 $22,283,000 $354,537,000 $112,547,000

2.00 Czarina S.A. (Brazil) -- -- - Foot Locker, Inc. $5,750,000,000 $251,000,000 $570,000,000 $3,249,000,000 $954,000,000

7.60 Pegasus International Holdings Ltd. -- -- - Rocky Brands Inc. $275,266,811 ($23,104,528) ($7,138,264) $216,724,527 $134,999,936

10.66) Skechers USA, Inc. $1,398,360,000 $75,686,000 $130,780,000 $827,977,000 $201,314,000

9.14 Timberland Co. (the) $1,436,451,000 $39,999,000 $90,197,000 $836,345,000 $259,185,000

4.78 Yue Yuen Industrial (Holdings) Ltd.