Foot Locker Inc. - Texas Tech University - Mark E....

Foot Locker Inc.

Financial Statement Analysis Valuation

Brandon Schaeffer, Lawton Johnson, Jesse Fender, Tucker Dalton, Charlie Hamilton

Table of Contents

Executive Summary……………………………………………………………………………………………… 8

Industry Overview……………………………………………………………………………………….9

Five Forces Model……………………………………………………………………………………….9

Accounting Analysis……………………………………………………………………………………10

Financial Analysis………………………………………………………………………………………11

Valuation Summary……………………………………………………………………………………12

Overview of Firms……………………………………………………………………………………………….12

Five Forces Model……………………………………………………………………………………………….13

Rivalry against Existing Competitors …………………………………………………………………….14

Industry Growth ……………………………………………………………………………………………15

Concentration ………………………………………………………………………………………………15

Differentiation ………………………………………………………………………………………………16

Switching Costs ……………………………………………………………………………………………18

Economies of Scale ………………………………………………………………………………………18

Exit Barriers ………………………………………………………………………………………………....19

Conclusion …………………………………………………………………………………………………….20

Threat of New Entrants ………………………………………………………………………………………20

Economies of Scale ………………………………………………………………………………………20

First Mover ……………………………………………………………………………………………………21

Distribution Access ………………………………………………………………………………………..21

Relationships ………………………………………………………………………………………………..22

Threat of Substitutes ………………………………………………………………………………………….22

Relative Price and Performance ………………………………………………………………………23

Buyers Willingness to Switch ………………………………………………………………………….23

Conclusion ……………………………………………………………………………………………………24

Bargaining Power of Customers …………………………………………………………………………..24

Bargaining Power of Suppliers ……………………………………………………………………………..26

Conclusion of the Five Forces Model……………………………………………………………………..28

Analysis of Key Success Factors for Creating Value ………………………………………………..28

Cost Cutting………………………………………………………………………………………………………..29

Differentiation ……………………………………………………………………………………………………30

Inventory Control………………………………………………………………………………………………..30

Key Accounting Policies………………………………………………………………………………………..31

Type One Key Accounting Principles………………………………………………………………………32

Differentiation….……………………………………………………………………………………….32

Investment in Brand Image……….……………………………………………………………….32

Product Variety………….………………………………………………………………………………34

Conclusion……….……………………………………………………………………………………….36

Cost Cutting………………………………………………………………………………………………………..36


Conclusion………………………………………………………………………………………………..39

Type Two Key Accounting Policies…………………………………………………………………………39

Operating Leases……………………………………………………………………………………….40

Conclusion………………………………………………………………………………………………..40

Potential Accounting Flexibility………………………………………………………………………………41

Actual Accounting Strategy…………………………………………………………………………………..41

Accounting for Operating Leases…………………………………………………………………………..42

Accounting for Goodwill……………………………………………………………………………………….42

Conclusion…………………………….………………………………………………………………….42

Qualitative Analysis……………………………………………………………………………………………..42


Differentiation…………………………………………………………………………………………………….44

Cost Cutting………………………………………………………………………………………………………..44

Conclusion………………………………………………………………………………………………..45

Identifying Potential Red Flags……………………………………………………………………………..45

Sales Manipulation Diagnostics..……………………………………………………………………………45

Net Sales/Cash from Sales………………………………………………………………………….45

Net Sales/Net Account Receivables……………………………………………………………..46

Net Sales/Unearned Revenue……………………………………………………………………..47

Net Sales/Inventory…………………………………………………………………………………..47

Core Expense Manipulation Diagnostics…………………………………………………………………48

Cash Flow from Operations/Net Operating Assets…………………………………………48

Cash Flow from Operations/Operating Income……………………………………………..48

Asset Turnover………………………………………………………………………………………….49

Undo Accounting Distortions…………………………………………………………………………………49

Financial Statement Analysis……………………………………………………………………….51

Liquidity Ratios………………………………………………………………………………………….51

Current Ratio…………………………………………………………………………………………….52

Quick Asset Ratio………………………………………………………………………………………53

Liquidity Ratio Conclusion…………………………………………………………………………..54

Operating Efficiency…………………………………………………………………………………………….54

Inventory Turnover……………………………………………………………………………………55

Working Capital Turnover…………………………………………………………………………..56

Day’s Supply Inventory………………………………………………………………………………56

Days Payable Outstanding………………………………………………………………………….57

Days Sales Outstanding……………………………………………………………………………..58

Cash to Cash Cycle…………………………………………………………………………………….59

Operating Efficiency Ratio Analysis Conclusion……………..................................60

Profitability Ratios……………………………………………………………………………………………….60

Gross Profit Margin…………………………………………………………………………………….61

Operating Expense Margin………………………………………………………………………….62

Operating Profit Margin………………………………………………………………………………63

Net Profit Margin……………………………………………………………………………………….64

Asset Turnover………………………………………………………………………………………….65

Return on Assets……………………………………………………………………………………….66

Return on Equity……………………………………………………………………………………….67

Profitability Ratios Conclusion……………………………………………………………………..67

Internal Growth Rate……………………………………………………………………………………………68

Sustainable Growth Rate………………………………………………………………………………………70

Capital Structure………………………………………………………………………………………………….71

Debt to Equity…………………………………………………………………………………………..71

Times Interest Earned……………………………………………………………………………….72

Debt Service Margin…………………………………………………………………………………..73

Altman Z score………………………………………………………………………………………….75

Capital Structure analysis conclusion……………………………………………………………76

Financial Forecasting……………………………………………………………………………………………76

Income Statement…………………………………………………………………………………….77

Balance Sheet……………………………………………………………………………………………78

Cash Flow Statement…………………………………………………………………………………79

Cost of Debt……………………………………………………………………………………………………….81

Cost of Capital…………………………………………………………………………………………………….84

Cost of Equity……………………………………………………………………………………………………..84

Alternative Cost of Equity Method…………………………………………………………………………87

Weighted Average Cost of Capital…………………………………………………………………………88

Methods of Comparables………………………………………………………………………………………91

Trailing P/E……………………………………………………………………………………………….91

Forward P/E………………………………………………………………………………………………92

Dividend to Price……………………………………………………………………………………….93

Price to Book…………………………………………………………………………………………….93

P.E.G. Ratio………………………………………………………………………………………………94

EV / EBITDA……………………………………………………………………………………………..95

Price / Free Cash Flow……………………………………………………………………………….95

Price / EBITDA………………………………………………………………………………………….96

Intrinsic Valuation Models…………………………………………………………………………………….97

Discounted Dividends…………………………………………………………………………………………..98

Discounted Free Cash Flows…………………………………………………………………………………99

AEG Model………………………………………………………………………………………………………..100

Residual Income Model………………………………………………………………………………………101

Long Run Residual Income Model……………………………………………………………………….103

Final Recommendation……………………………………………………………………………………….104

Appendix………………………………………………………………………………………………………….106

Work Cited………………………………………………………………………………………………………..119

Executive Summary

Footlocker (FL) NYSE Altman's Z Scores

2011 2012 2013

Observed Price 10/31/14

$ 56.10 Z-Score 5.2 6.1 7

52 week range

$59.19 - $36.65

Revenue

7.03B Methods of Comparables Valuation

Market cap

8.26B

Shares Outstanding

Trailing P/E

$ 55.00

Book Value per share

17.86 Forward P/E

$ 55.59

Return on Equity

19.53% P.E.G

$ 60.71

Return on Assets 13.65% Dividends/Price

$ 74.23

Cost of Capital Price/Book

$ 8.34

EV/EBITDA

$ 47.62

Adj. R^2 Beta Size Adj. Ke Price/EBITDA

$ 46.71

3 month 21.31% 1.03 4.12% Price/FCF $ 134.00

1 year 22.89% 1.13 4.61% Intrinsic Valuations

2 year 22.88% 1.13 5.07%

7 year 22.91% 1.13 6.73% Discounted Dividends $ 14.57

10 year 22.92% 1.13 7.04% Free Cash Flows

$ 17.81

Residual Income

$ 24.22

Backdoor Ke

6.05%

Long-run Residual Income $ 20.47

WACC

7.08%

Abnormal Earnings Growth $ 23.14

Beta 1.22

Overvalued (Sell)

Industry Overview

Foot Locker, Inc. (NYSE: FL) was founded in 1879 by F.W. Woolworth and is an

athletic footwear and apparel retailer operating in the retail store and online business

space. In this industry the key success factors are cost-cutting, inventory control, and

differentiation.

Five Forces Model

Factors we will discuss include industry growth, concentration, differentiation,

switching costs, learning economies, and exit barriers. The five forces model is shown

below.

After evaluating the athletic retail industry using the five forces model, we

believe that the industry is highly competitive. Firstly, among existing competitors there

is low levels of concentration, and slow industry growth. There is also a high threat of

Rivalry Against Existing Firms

Threat of New Entrants

Threat of Substitute Products

Bargaining Power of Buyers

Bargaining Power of Suppliers

Porter's Five Forces

new entrants in the industry due to low barriers of entry. The ability to substitute or

trade out products within the industry is another competitive driver of competition,

resulting in a high threat of new substitutes. Athletic retailers rely on a small group of

companies for their entire inventory, combining this with the fact that retailers add

nothing proprietary, supplier’s bargaining power is high in this industry. The customers

bargaining power is very low because the inventory is all purchased from suppliers who

set the prices. Therefore, all of the industry is going to have nearly the same prices for

the same products giving customers real no bargaining power.

Accounting Analysis

Accounting policies are the specific methods and procedures a company uses to

disclose its financial statements. Accounting principles, also referred to as Generally

Accepted Accounting Principles (GAAP), are conventions which companies must adhere

by when choosing how they wish to state assets and liabilities. Companies may choose

to reveal or reserve certain information which can be very useful for analysts in making

investment decisions. Disclosure requirements constrain management’s ability to alter

financial data, thereby creating noise as firms try to maneuver around certain treatment

of information. Accounting analysis is used to assess the level to which firms accounting

practices capture the real business and to undo any biases.

Furthermore, companies are able to decide which accounting strategies they want

to use in releasing such information. Accounting policies vary by industry, so firms tend

to use those policies which are uniform across their relative industry and competition.

The use of similar accounting policies within an industry makes the analysis of individual

accounting strategies an important and difficult part of the valuation process.

There are two different types of key accounting policies we will define. The first,

Type One, Key Accounting Policy has to do with an industry’s key success factors. For

the specialty athletic footwear and apparel industry the key success factors include:

cost-cutting, differentiation, and inventory control. Due to the industry importance

managers will likely provide specific figures, and footnotes to help better inform

investors about these topics. The second, type two, key accounting policy has to do

with “significant items” that managers have the ability to influence or change. This is

important to analyze because it allows room for distortion of figures. It can also be

proof of transparent management, for instance if the flexible information is stated for

beneficial use instead of a cover up, then it’s a good sign. Some Type Two figures could

include: goodwill, foreign currency exchange, and leasing activities. After looking into

the key accounting policies of Foot Locker and its competitors, a better level value can

be determined.

Financial Analysis

An important step in placing the value on a company is ratio analysis. This

involves interpreting past the information from the financial statements to analyze

variables such as company structure, profitability, trends, as well as relative

performance to competitors, and other information useful in estimating intrinsic value.

Footlocker will be analyzed based upon liquidity, operating efficiency, profitability, and

capital structure.

The profitability ratios for Foot Locker showed that they are mostly

underperforming against the industry. Although their ratios weren’t always the best in

the industry they are by no means doing badly. They are consistently leading the

industry and in most cases have an improving margin over the past 6 years. When

looking at net profit margin and return on assets, Foot Locker was underperforming

against the industry between 2009 thru 2012 and then surpassed the industry to

become the leader from 2013 to current. Foot Locker was able to surpass the industry

by diversifying their product lines by acquiring more subsidiaries and therefore increase

their customer base. Overall, Foot Locker is staying competitive in the industry in

regards to profitability.

Valuation Summary

Through the use of intrinsic valuation models we can more precisely find a value

for Footlocker. The models used are more accurate for a few reasons; they use

historical data instead of just one year, it incorporates the cost of capital in the model,

and takes into account time value of money. Five of these valuation models will be

used: discounted dividend, discounted free cash flow, residual income, long run residual

income, and abnormal earnings growth. After creating these models we will have a

good guidance as to how Footlocker is valued.

When the models are completed we can then use sensitivity analysis to get a

better understanding of what drives value. By changing variables we can test the limits

of a firm and see when they are valuable, and when they are not. We can then use

these multiple variables as adjustments for our forecasting. Since we are established as

10% analysts based upon the share price of 56.1 we will consider a valuation under

50.49 to be overvalued and a valuation above 61.71 to be undervalued. These models

combined with our comparables prices will ultimately determine whether or not our

company is worth buying or selling.

Show by the long run residual income model, and most other valuation models

Footlocker appears to be overvalued. The closest Footlocker gets to becoming fairly

valued is when ROE was held at the constant 19%, this was due to a low cost of equity

and growth rate. Re-iterating from our models before Footlocker is an overvalued

company.

Overview of Firm

Foot Locker, Inc. (NYSE: FL) was founded in 1879 by F.W. Woolworth and is an

athletic footwear and apparel retailer operating in the retail store and online business

space. As of 2013, Footlocker operated over 3,350 stores in 23 countries across North

America, Europe, Canada, Australia, and New Zealand. Its portfolio has grown over the

years to include men’s, women’s, and kid’s stores under than names Foot Locker, Lady

Foot Locker, and Kids Foot Locker. Foot Locker has expanded its footprint in the past 50

years by adding stores that cater to varying demographics who are influenced by

athletic styles. Champs Sports and Footaction were founded in the 1970’s and target

the young male looking for the “one-stop shop” for athletic shoes and clothes. In the

2Q 2013, Footlocker acquired the German based Runners Point Group, along with its

stores Runners Point, Sidestep, and Run2 in order to target the serious runner.

Footlocker introduced SIX:02 in November 2012, a newer store concept offering

women’s fitness clothing and footwear. The Direct-to-Customers segment consists of

Footlocker.com, as well as affiliate companies Eastbay, Inc., CCS, and Tredex, the

online subsidiary of Runners Point Group. Competition in the apparel and footwear

industry is highly competitive with many types of retailers offering similar products and

services. For our valuation, we have chosen to analyze and evaluate the financial

information for Footlocker, Inc., Finish Line, Inc., and Dick’s Sporting Goods. These

companies offer very similar products and services and each are publicly traded.

Five Forces Model

The five forces model is a competitive analysis tool used by firms and analysts to

determine what drives value in an industry, and the company being valued. Porter’s

Five Forces include, Rivalry against existing firms, threat of new entrants, threat of

substitute products, bargaining power of buyer, and the bargaining power of suppliers.

By determining which forces are important in an industry we can measure how well a

company works within the industry.

Rivalry Amongst Existing Competitors

The retail industry as a whole is considered highly competitive. Being able to

efficiently use assets, and keep costs low is key. A few main distributers provide the

industry with their products putting more stress on supplier relationships, and creating

low product differentiation between competitors. Also stores are located close to one

another; Mall’s are flocking grounds for different retailers, which means a customer has

the ability to quickly compare one store to another. This causes tight pricing strategies,

high rivalry, and a focus on cutting expenses to squeeze out low margin profits.

There are many factors that go into the level of existing competition. Figuring

out these factors, and taking advantage of them will give companies the higher margins

needed to be successful in retail. Factors we will discuss include industry growth,

concentration, differentiation, switching costs, learning economies, and exit barriers. All

corporations must stay aware of these competitive statistics to either keep in line with

the retail average, or exploit ways to edge out profits over one another.

Rivalry Against Existing Firms


Threat of Substitute Products

Bargaining Power of Buyers


Porter's Five Forces

Industry Growth

A valuable measure of how well a company does in its industry is to compare

growth. While growth of 25% can be good, if your two other competitors are growing

at 30% then there are apparent problems. Shoe and clothing retail is a 220 billion dollar

industry, split up amongst 33,000 firms. The industry growth rate over the last 10 years

has averaged 3.27%, this gives a good starting point for comparing the competition as

a whole.

The retail sector as a whole is very slow and consistent. Clothing and shoes have

been so engrained into human culture that most everybody in the world buys clothes on

an annual bases, creating a very saturated market. A fair assumption is that retail

growth is heavily influenced by population growth since everybody buys clothes and

shoes. Because clothes have become a necessity a lot of profit seekers flock to this high

revenue sector in order to get their cut of the 220 billion dollars. This bring a lot of

competition, saturation brings slow growth, and apparel shopping stays fairly consistent

through economic changes. These factors are what define growth in the retail industry.

It’s a close game when it comes to retail industry growth. Growth in profits can

be found easier in cutting costs and raising efficiency, then by marketing to create more

sales. Keeping an eye on inventory will be a key value adding practice. Also with a

recent increase in management information systems management teams have more

access to sales details. This not only gives the opportunity to fix small changes

necessary, but everyone, even competition, can take advantage of it. Management is

expected to constantly find new improved ways to use this information to create a more

efficient business.

Concentration

Concentration helps describe how competitive an industry is by measuring how

much of the total sales are made up by the top 4, 8, 20, and 50 firms. If 100% of the

sales come from the biggest four companies then there may be some form of monopoly

going on, which means high concentration and low competition. If the sales are split up

amongst 50 or more different firms than there is low concentration and high

competition.

Concentration

geographic area sector number of firms

number of establishments

sales % of whole

United states athletic footwear stores All firms 6,528 100%

United states athletic footwear stores 4 largest 4,214 68.40%




In our case it looks like there is a low market concentration in the athletic

Footwear stores industry. The four largest firms take up 68.4% of the sales revenue.

Based off this Information we can assume that there are few barriers to entry, no one

company is monopolizing the profits, and customers have a wide variety of choices.

Also because there are so many competing establishments it will be more likely to see

multiple competing firms at shopping locations. This gives the individual firms less

power over the prices at which they can effectively sell their products.

Differentiation

In a competitive market like retail the ability to differentiate is how you get

customers to come into your store first before going to others. When the thousands of

different places to shop are all selling the same products at the same price the little

differences become magnified, and can make or break a company. The way advertising

has advanced in the last few years, being able to put your name in the customers head

will help differentiate from the competition. Another important factor would be store

appearance. The ability to draw an impartial customer into a store based upon visual

appeal can also help differentiate.

Advertising can be done online, through television, by mail, etc. When customers

pick stores based off personal preference instead of price, than branding and exposer to

a brand brings in the revenue. You can see on the chart below how much money is

spent on advertising. These costs have to be made up in order to be valuable, so this

form of differentiation in theory adds millions of dollars in profit.

Net

advertising

expense

2009 2010

2011 2012 2013

Foot Locker 64,000,000 74,000,000 $99,000,000 $107,000,000 $102,000,000

advertising exp/ sales

1.32% 1.47% 1.76% 1.73% 1.57%

Finish Line 17,792,000 16,736,000 $27,980,000 $30,650,000 $31,970,000

advertising

exp/ sales 1.49% 1.43% 2.28% 2.24% 2.21%

Dicks

Sporting 160,100,000 185,200,000 $187,400,000 $201,000,000 $223,900,000

advertising exp/ sales 3.63% 3.80% 3.60% 3.44% 3.60%

Most of the competitors in the clothes and shoes retail industry are located in malls or

established shopping outlets. Keeping stores attractive will leave a lasting impression

that brings customers back into the stores first. This can be measured through

alterations/renovations to buildings. As you can see the bigger the companies the more

they spend on renovations. Over the lifetime of a company a billion dollars could be

spent simply renovating stores. This is a sign of high competition and will contract

margins for the entire industry.

Money spent on

alterations/renovation to leased

and owned buildings - before depreciation

2009 2010 2011 2012 2013

Foot Locker 701,000,000 713,000,000 729,000,000 772,000,000 804,000,000

Finish Line 250,031,000 225,718,000 223,485,000 227,080,000 239,555,000

Dicks Sporting 516,419,000 589,427,000 679,001,000 736,005,000 895,798,000

Differentiation has its costs, but are valuable when the benefits outweigh the

costs. The well-established industries have clearly taken steps towards differentiating

themselves from the mediocre sports clothing retail. Whoever can manage all these

necessary costs the best will produce better income than the competition.

Switching costs

Switching cost has great influence on how well a company can keep customers

shopping at their store. It comes down to how easy it is for a customer to switch

products. Trying to control something like switching costs in retail is nearly impossible.

Switching is almost natural and necessary in the clothing/shoe industry because most

people like to differentiate their clothes and buy from multiple retailers. If a retailer

tried to enforce some form of switching cost than the consumer would find it easy to

just shop with other business, likely next door. Switching costs are low amongst all

existing competitors, and trying to control this factor may not gain much value.

Economies of scale

In theory as a company gets bigger its fixed costs will be split against a higher

quantity of products, reducing costs. Efficiency would also improve in an economy of

scale. If a company can take advantage of this by intelligently expanding operations

than large profits can be found, it can put pressure on competitors lowering their

margins, and simultaneously improve its own margins. Information to help recognize

economies of scale would be return on assets, and operating income margin.

Economies of scale exist within the retail clothing industry. As you can see the

larger the asset base the ratios to show efficiency and income are slightly larger.

Important assets in this industry would include inventory, lease space, and store

fixtures; the ability to produce better profits from total assets will help capitalize on the

economies of scale for a company. Operating income margin also seems to increase

with higher asset companies. This is due to the reduced costs of creating more products

more efficiently as assets are put to better use.

Exit barriers

Exit barriers describe how difficult it is to leave a market if a company fails.

When exit barriers are difficult or expensive than new entrants will have to weigh in the

2009 2010 2011 2012 2013

Footlocker Total

assets 2,877,000,000 $2,816,000,000 $2,896,000,000 $3,050,000,000 $3,367,000,000

Net income 48,000,000 $169,000,000 $278,000,000 $397,000,000 $429,000,000

ROA 1.67% 6.00% 9.60% 13.02% 12.74%

Operating

income margin 1.70%

5.30% 7.80% 9.90% 10.30%

Finish Line

Total assets 598,700,000 $610,268,000 $664,845,000 $711,496,000 $706,400,000

Net

income $3,800,000 $35,700,000 $68,800,000 $84,800,000 $71,500,000

ROA 0.61% 5.90% 10.80% 12.32% 10.08%

Operating income

margin 4.52% 6.72% 9.02% 9.88% 8.17%

Dicks

Sporting

Total

assets $1,961,800,000 $2,245,300,000 $2,597,536,000 $2,996,452,000 $2,887,807,000

Net income -$39,900,000 $135,400,000 $182,100,000 $263,900,000 $290,700,000

ROA 2.00% 6.40% 7.50% 9.40% 9.90%

Operating

income

margin 5.80% 5.30% 6.30% 8.30% 9.00%

risk of failure. In the retail market exit barriers are moderate. Due to the high inventory

costs it can be costly to liquidate a retail company, especially if you can’t sell your

products. Another exit barrier would include the long lease agreements; when the

normal life of a lease is 10-15 years it doesn’t matter if you aren’t in business, you still

have to pay rent. What keeps exit barriers moderate can be summed up as the bigger

they are the harder they fall; so if you’re just a family retailer it won’t hurt as bad to

fail, enticing a lot of new entrants.

Conclusion

The retail industry is a slow growth industry with lots of competitors. By studying

industry growth, concentration, differentiation, switching costs, economies of scale,

learning economies, and exit barriers, it is reasonable to assume that the rivalry

amongst existing competitors is extremely high. Fighting over the low growth and thin

market share just leads to low margins and a focus on operational efficiency.


The threat of new entrants is extremely HIGH. Starting a shoe and apparel store

does not require a lot of technology or assets. With low barriers of entrance into the

apparel and footwear industry, future competitors can arise anytime. We will discuss

five factors in this section.

Economies of Scale

Economies of scale pertain to the size of an operation relative to the cost per

unit. Generally the larger the operation the smaller the cost per unit becomes. A

company can have a competitive advantage if they put economies of scale to use. In

the athletic apparel and footwear industry if a company can cut cost in the operation of

obtaining products, they can stay competitive in the industry.

First Mover

There are advantages and disadvantages to being the first mover. Being the

first firm to market a product means that the firm has the best understanding of the

product and can create barriers to other companies entering the market. Another

advantage is being able to negotiate with suppliers before other competitors can so that

they will not have access to the best suppliers and other important resource providers.

This allows the first mover to operate more efficiently than other competitors who may

enter the market later. One of the biggest disadvantages of being the first mover is that

entering a new market can result in mistakes as the first mover is learning the industry.

These can be expensive mistakes and competitors who enter the market later will

potentially learn from the mistakes of the first mover. When a market becomes

saturated like the athletic apparel and footwear, there is not much of an advantage to

changes being made by a first mover. A saturated market can experience competition

from an emerging market

Distribution Access

Having an efficient distribution channel for goods is important to the success of

the athletic footwear industry. Moving products from the national producers to the

retailer in a timely way is critical to retail success. Finding producers with regional

distribution centers allows the company to reduce shipping costs and keep inventories

of products high in the retail stores. If store inventories of desired products are low, the

consumer will likely buy the desired products from a competitor. Suppliers must be

identified that can promise to deliver the needed goods efficiently and in the numbers

needed. Negotiating commitment contracts with suppliers can allow the company to

have priority over other companies in the same industry because the supplier knows

that the company will be using them for future supplies. Having a commitment contract

also allows the company to protect itself against price changes which will reduce costs

to the company and to the consumer. Keeping distribution costs low allows the

company to be more competitive in the athletic footwear industry.

Relationships

Relationships with suppliers of the products sold in the retail stores are critical to

the success of the company. When problems arise with inventory, these relationships

are what will allow the problems to be resolved. The relationships can be formalized

through contracts which allow both the supplier and the company to know that they are

making a commitment to do business with each other for a period of time. Competitors

then cannot do business with the same supplier limiting the competitor’s access to the

products and creating a barrier for them. Without contracts with suppliers, it is

important that the relationships stay positive because the suppliers can pursue

relationships with competitors at any time.

This industry relies heavily on mall traffic. With only several large mall landlords

in the United States, it is necessary to have and maintain a strong relationship with

them. Maintaining a good relationship with mall landlords allows a company to obtain

prime store locations and preserve agreeable lease terms.

Threat of Substitutes

The threat of substitutes is defined by Porter as the obtainability of a product

from a related industry that is characteristically similar and priced competitively to the

product in demand, also known as the industry’s product. The threat of substitute

products is a key indicator of competition within the retail industry largely because the

price of one product can influence the demand for another.

We are analyzing the athletic footwear and apparel sub-sector of the retail

industry. It is important for specialty retailers of athletic wear such as Foot Locker and

Finish Line to manage price competition so as to enhance demand and profitability

without compromising the integrity of the retailer’s brand equity and the quality of its

merchandise. In the retail industry, overall threat of substitute products is very high. In

general, consumers are price sensitive and are willing to substitute a pricier product

from a specialty retailer with that of a similar product from a department store or

general sporting goods store.

Relative Price and Performance

In analyzing the threat of substitute products, we have mentioned that price and

quality are key in forming assumptions about whether or not a substitute product

exists. In terms of relative price, we are observing the switching cost associated with

the availability of an alternative product. The retail industry consumes a large part of

the overall market, indicating to us that the costs of switching from the industry product

to the substitute product are very low. Additionally, if the relative quality and

performance of the substitute product is similar to that of the industry product, then a

threat of substitute is further reinforced. Specialty stores compete on the exclusivity of

supplier relationships and advertisement campaigns, where larger retailers who conduct

business in a wider variety of related industries are able to take advantage of the

leftovers.

Buyers Willingness to Switch

The buyers’ willingness to switch to substitute products is mainly a function of

the costs he or she may incur if they decide to switch to that product. In the retail

industry, it is easy to switch products at little to no cost. In the specialty retail space, a

buyers’ willingness to switch products will depend on how loyal they are to the retailer

in question and how much quality and performance they are willing to sacrifice in order

to save costs. There are many places buyers can turn to for a similar product, so

switching costs are a small factor and willingness to switch is very high. While Foot

Locker operates specialty stores offering athletic wear exclusively, buyers may be able

to find a similar product at Dick’s Sporting Goods which has a higher differentiation of

products. Buyers may be able to take advantage of cost advantages in this way. Since

specialty retailers set the price ceiling for the industry product, buyers will then assess

their loyalty to the specialty store. It is imperative that retailers like Foot Locker and

Finish Line promote sales methods by using coupons, rewards cards, and special sales

periods in order to retain customer loyalty and to stay competitive with competing store

prices and large discount retailers with a wider variety of product offerings.

Conclusion

We conclude that the threats of substitutes in the retail industry are high. In

general, consumers will sacrifice the industry product of high demand for the substitute

product if there is a competitive price and performance associated with it. Specialty

retailers impose a ceiling on the price customers are willing to buy, while customers will

find alternative sources for a similar product. It is important for retailers to maintain

their brand equity, quality product lines, and intimate in-store relationships in order to

mitigate the threat of substitutes.

Bargaining Power of Customers

The bargaining power of customers for apparel and shoe industry is very low due

to the fact that retail does not have any of its own brands. This retail sector only sells

other brands from suppliers who set the price for shoes and apparel. The price of the

shoes and apparel will rarely differ in any other stores or online giving the customer

virtually no bargaining power. There is almost nothing holding customers to be loyal to

any specific entity due to the non-existent switching cost. Customers can freely buy

from other suppliers with no kind of backlash.

The industry sells a vast array of shoes and apparel for almost every personal

consumer need. They do this in store while also having a wide online presence. The

prices for the different products are virtually the same, giving each entity no real price

advantage in the market place. There is also direct from supplier to consumer

availability for most products so it is important for the industry to establish their place in

the market by offering incentive and free shipping.

With the average American female buying 5 pairs of shoes a year and Men

buying 2 pairs there is always going to be a need for shoes no matter what the market

is doing. (Facebook Survey) It may see its ups and downs but people will always buy

shoes, giving retail a consistent advantage in the market. With the target market for

this industry including most of the population there will always be buyers for the

products they provide.

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

Foot Locker Dick's Finish Line

Nike Mens Free 5.0 Running Shoe Nike Pro Combat Core Compression Shorts

This industry is highly competitive because of the similar pricing between the

industry’s leading competitors. It is nearly impossible for anyone company to gain

competitive advantage over the others because they all have a large in store presence

as well as online. As well as offering mostly the same product lines with almost no

exclusivity to a specific company in the industry.


Footlocker competes in the specialty retail industry; selling athletic footwear and

apparel. The merchandise in this industry is supplied almost completely by a small

group of companies, none of whom are the retailers themselves, meaning the suppliers

have relatively more bargaining power than those in most other industries. The main

suppliers of the merchandise in this industry are Nike, Adidas, Reebok, Puma, New

Balance, and Under Armor.

Nike is by far the largest of these companies, for example, Nike products

constitute sixty eight percent of footlocker’s sales. All of these companies have similar

products therefore the power, success, and differentiation of these suppliers is derived

almost completely from their branding. Branding all comes down to the psychology of

people, specifically as consumers. Near the top of Maslow’s hierarchy of needs is

esteem. People want to like themselves while at the same time having others like them

too, people want to feel like they’re part of the community. A sense of community can

be subconsciously achieved a multitude of different ways, one of which is from

something as small as a logo.

For most people there is a comfort factor knowing that you have the same logo

on your shirt as is on your favorite athlete’s jersey, your best friend’s shoes, or even the

backpack of someone walking down the street. The footwear and apparel industry is

one that uses the psychology of branding to their advantage; others that do the same

would be the auto and tech industries. Because of this innate desire to fit in, a herd

mentality, the apparel industries tends to gravitate towards a small group of brands

controlling the sector. The more people that wear a brand, the more recognizable it

becomes thus causing more people to want to wear that brand, in other words it’s

exponential growth. People have loyalty to the brands they wear but not where they

buy it, companies like Nike know this and use it as bargaining power when dealing with

retailers. Nike knows that a sportswear retailer can’t afford to not carry their products,

leverage that is of great financial benefit to them.

Another piece of leverage that the footwear and apparel companies use in

negotiations is their ability to sell directly to consumers via their websites. The internet

has changed every aspect of society, including the way people buy things like shoes.

The only reason why the internet hasn’t completely decimated retailers like footlocker is

attributable to three things. With an online purchase there are shipping costs, then you

have to wait for it to come in the mail, people prefer instant gratification. Lastly, most

consumers like to try something on before they buy it. This is what constitutes the little

amount of leverage retailers have when negotiating with suppliers. The suppliers hold

almost all of the bargaining power because at the end of the day, the retailers add little

to no value.

The switching cost aspect can be looked at from a few different perspectives,

that of the consumer, the retail firm, and the supplier. Consumer switching costs are

nonexistent, unless you consider the shipping fee for online ordering a switching cost.

As mentioned earlier, due to the branding aspect of footwear and apparel, switching

isn’t really an option for the retailer. The supplier could switch to another retailer, but

there’s no need to seeing as a company like Nike doesn’t have to pick just one retailer,

they can sell their merchandise everywhere. So for the most part, switching costs in this

industry are negligible.

Conclusion of the Five Forces Model

After evaluating the athletic retail industry using the five forces model, we

believe that the industry is highly competitive. Firstly, among existing competitors there

is low levels of concentration, and slow industry growth. There is also a high threat of

new entrants in the industry due to low barriers of entry. The ability to substitute or

trade out products within the industry is another competitive driver of competition,

resulting in a high threat of new substitutes. Athletic retailers rely on a small group of

companies for their entire inventory, combining this with the fact that retailers add

nothing proprietary, supplier’s bargaining power is high in this industry. The customers

bargaining power is very low because the inventory is all purchased from suppliers who

set the prices. Therefore, all of the industry is going to have nearly the same prices for

the same products giving customers real no bargaining power.

Analysis of Key Success Factors for Creating Value

In the business world being able to recognize the factors for success before even

starting will save time, money, stress, and lower the chances of failure. Retail is a large

and consistent industry so success factors won’t vary much from company to company.

By determining what these factors are we can apply them to the industry as a whole to

see how well current companies are creating value. Through our analysis we’ve

discovered that the most importing success factors for creating value include: cost-

cutting, inventory control, and differentiation.

The retail sector is a low margin slow growth industry. When this is the case a

company can find better growth in profits by cutting costs, than in fighting over slow

industry growth. Doing this can also add stress on other companies because you can

sell products cheaper than them. Management is probably the biggest influence of cost-

cutting. The ability to efficiently use assets, and take advantage of economies of scale,

will create value and earn profits.

Cost-cutting

Footlocker is managing cost-cutting very well. A financial sign to prove this would

be an increase in net income ratio; a sign that footlocker has a competitive advantage

over the competition would be if they have a higher average net income ratio.

net

income

ratio 2013 2012 2011 2010 2009

Foot

Locker 6.59% 6.42% 4.94% 3.35% 0.99%

Finish Line 4.95% 6.19% 5.60% 3.04% 0.31%

Dicks 4.98% 5.06% 3.74% 3.07% 0.33%

As you can see Footlocker has consistently held higher margins over its

competitors. This is extremely good and shows a healthy, well managed, company. This

will have a positive impact on the company’s considered intrinsic value.

Footlocker also has six different distribution centers. Having these located all

over the world is necessary for controlling costs. Three are located in America, two in

Germany, and one in the Netherlands. These large asset bases will only get more and

more efficient as experience is gained through past operations. New management has

proved with profit margin that they can efficiently utilize an important part of

Footlockers assets, which cuts costs, and adds value to the company.

Differentiation

In the athletic shoe and apparel industry it is important for the different entities

to differentiate themselves from others in order to succeed. They must take the same

products that all of the industry is selling and present them in a way that appeals to the

customer and pulls them into their store or website over others. This industry in

particular is heavily reliant on differentiation in order to be competitive in the market

place. They must find innovative ways to pull customers into their stores in order keep

market share.

Foot Locker Inc. has done a tremendous job when it comes to differentiation.

They have several subsidiaries including Foot Locker, Lady Foot Locker, Kids Foot

Locker, Footaction, Champs Sports, Eastbay, CCS, Runners Point, and Sidestep which all

cater to individual segments of the athletic shoe and apparel market. This allows them

to reach every corner of the market and provide wants for customer base in nearly

every way giving them a competitive advantage. Foot Locker Inc. has also devoted a

lot of resources and time into advertising, and leasehold improvements successfully

differentiate themselves apart from their competitors

Inventory Control

Footlocker successfully manages the key success factors for efficient supply chain

management, part of the reason they’ve grown to the largest company in their space.

They own their own trucks, and half their distribution centers which lower the cost

significantly. Having to pay a distribution company is expensive and cuts in to the

already slim margins. The next key success factor, inventory management, is a strength

for footlocker. Their DIO (day’s inventory outstanding) has dropped from 115.7x in

2009 to 100x in 2013 while at the same time their inventory turnover has risen from 3.1

to 3.7x over the same period. This increase in efficiency is due to the closing of

nonproducing stores. Lead times for footlocker are low. With 6 global distribution

centers and a constant stream of transportation, customers are able to receive an out

of stock item within 2 days. Supply chain management can make or break a retail

company and footlocker has mastered it. .

Key Accounting Policies

Accounting policies are the specific methods and procedures a company uses to

disclose its financial statements. Accounting principles, also referred to as Generally

Accepted Accounting Principles (GAAP), are conventions which companies must adhere

by when choosing how they wish to state assets and liabilities. Companies may choose

to reveal or reserve certain information which can be very useful for analysts in making

investment decisions. Disclosure requirements constrain management’s ability to alter

financial data, thereby creating noise as firms try to maneuver around certain treatment

of information. Accounting analysis is used to assess the level to which firms accounting

practices capture the real business and to undo any biases.

Furthermore, companies are able to decide which accounting strategies they want

to use in releasing such information. Accounting policies vary by industry, so firms tend

to use those policies which are uniform across their relative industry and competition.

The use of similar accounting policies within an industry makes the analysis of individual

accounting strategies an important and difficult part of the valuation process.

There are two different types of key accounting policies we will define. The first,

Type One, Key Accounting Policy has to do with an industry’s key success factors. For

the specialty athletic footwear and apparel industry the key success factors include:

cost-cutting, differentiation, and inventory control. Due to the industry importance

managers will likely provide specific figures, and footnotes to help better inform

investors about these topics. The second, type two, key accounting policy has to do

with “significant items” that managers have the ability to influence or change. This is

important to analyze because it allows room for distortion of figures. It can also be

proof of transparent management, for instance if the flexible information is stated for

beneficial use instead of a cover up, then it’s a good sign. Some Type Two figures could

include: goodwill, foreign currency exchange, and leasing activities. After looking into

the key accounting policies of Foot Locker and its competitors, a better level value can

be determined.

Type One Key Accounting Principles

Differentiation

The differentiation strategy seeks to offer a product or service that is uniquely

important and highly valued by the customer. In the specialty athletic footwear and

apparel industry, firms attempt to differentiate themselves on the basis of product

variety, investment in brand image, and flexible delivery. Type One Accounting Policies

are closely associated with the differentiation strategy firms develop in the specialty

retail industry. Below, we will discuss Foot Locker and its competitors’ Key Success

Factors as they relate to the level of disclosure management has provided in the SEC

filings and investor relations.

Investment in Brand Image

Brand image is a huge success factor for specialty retailers, which can lead to

increased brand recognition, store traffic, and sales. We can observe investments in

brand image by looking at a industry’s advertising expense. For example, during 2012

Foot Locker increased its marketing and advertising expense by $8 million. This move

was made to differentiate the retailer’s various formats, and was done so through use

of wide mix of broadcast, digital, print, and numerous sports sponsorships. (FL 10-K).

Foot Locker’s level of disclosure for marketing and advertising expense is moderate

good. These firms do not itemize advertising expense separately from SG&A, however,

Foot Locker, Finish Line, and Dick’s include supplementary data which provides the

portion of SG&A that is marketing and advertising related. This is useful information for

investors and analysts since so much of the athletic footwear and apparel industry’s

profits are derived from brand recognition. Foot Locker shows Net Advertising expense

as $99 million, $107 million, and $102 million in 2011, 2012, and 2013, respectively.

These figures are net of Cooperative reimbursements, which are reimbursements

“earned for the launch and promotion of certain products agreed upon with vendors”,

and are ultimately taken out of cost of goods sold (FL 10-K). Advertising expenses

include marketing campaigns and catalog distribution as well. Dick’s Sporting Goods

treats cooperative reimbursements the same way that Foot Locker does, however Finish

Line does not mention where the cooperative advertising refunds are accounted for

(DKS 10-K, FINL 10-K). Below is a table showing advertising expense per company as a

percentage of overall selling, general, and administrative expenses.

Since 2009, advertising expense as a percentage of total SG&A expense has

grown substantially for Foot Locker and Finish Line. This is a direct result of Foot

Locker’s strategy to differentiate its store formats from each other (FL 10-K). As noted

previously, Foot Locker operates men’s, women’s, and children’s store formats, as well

as the newly acquired Runner’s Point group which caters to the serious runner. It is

particularly important for Foot Locker to send a message to its consumers about their

various store formats and target markets. On the other hand, Finish Line operates a

standard store that attempts to attract all of its customers in one place. Their

advertising expense is tied directly with the promotional agreements made between

Finish Line and their Suppliers. Finish Line also cited “The Winners Circle” as a customer

loyalty program used to inform customers of special promotions and new offerings,

while also offering $20 gift cards to customers who spend at least $200 in a 12 month

period. Finish Line realized a 13% increase in their membership base, reinforcing their

growth in advertisement expense (FINL 10-K). Dick’s has a much broader strategy for

marketing, using all forms of media to build brand loyalty through advertising

campaigns and also through sponsorship of sports teams at the community level. Their

decline in advertising expense is related to their gradual reduction in paper and mail

advertising and an increase in SG&A linked to higher payroll costs, charitable

contributions, and a partial reversal of a court dispute in 2011(DKS 10-K). All in all, Foot

Locker and its competitors disclose a good amount of information regarding their

strategies for investment in brand image.

Product Variety

The variety of products that firms offer in the specialty retail industry is vital to a

firm’s success. We can determine the variety of goods and services a firm provides by

looking at their store offerings compared with their competitors. Foot Locker

differentiates itself from its competitors by offering different store formats that target

different age and gender groups. While most of their athletic store competition also has

direct-to-customer businesses (e-commerce), Foot Locker is unique in that its stores are

branded under different names because they serve different customers, such as Lady

Foot Locker and Kids Foot Locker. Foot Locker acquired Runner’s Point Group in 2013, a

German company which targets runners exclusively. Foot Locker bought Runners Point,

Sidestep, and Run2 along with Tredex, its direct-to-customer business for, $87 million in

cash (FL 10-K). The company estimates acquisitions costs by estimating the fair value

of the assets and liabilities of the target business (FL 10-K). Management discloses in

their 10-K that estimates are internally calculated with the assistance of third-party

valuation experts. This acquisition is poised to grow Foot Locker’s foothold in Germany,

while acting as a platform for future European expansion projects. For 2013,

management shows that the acquisition provided an additional $164 million in sales.

Additionally, Foot Locker announced a new store concept aimed at women’s fitness

groups. SIX:02 offers top brand yoga, aerobics, dance, and CrossFit apparel and shoes.

In a company news release, Executive VP of Marketing Stacy Cunningham

describes the store as a place “to find premium fitness and athletic gear that allows her

to combine her personal style and versatility with performance features” (FL News

Release Nov. 2012). In 2012, 3 stores were opened for testing in Samford, Conn., San

Antonio, Texas, and Wayne, N.J., returning positive sales results. Management added 4

new stores in 2013, bringing a total of 7 SIX:02 stores in the U.S., Puerto Rico, and the

U.S. Virgin Islands (FL 10-K). It is unclear what the initial cost of launching these 7

stores was. All of the same footwear suppliers provide merchandise to the SIX:02 store,

with the exception of newer suppliers in the aerobics and yoga market such as Pink

Lotus, Colosseum, and Spanx (News Release Nov. 2012).

Similarly, Finish Line completed 4 smaller acquisitions of specialty running stores

for $13 million in cash. Finish Line also used fair value and discounted cash flow

techniques to estimate the cost of purchases (FINL 10-K). Dick’s operates a different

business model than Finish Line and Foot Locker with its “store-in-store” concept, which

combines athletic apparel and footwear, game and lodging, and outdoor pursuits.

Management reveals that it has recently made smaller investments in specialty running

store True Runner, opening 1 in the last year and bringing the total to 3. The company

has also made a small investment in specialty outdoor store Field & Stream, opening 2

in the last year with plans to expand further in 2014 (DKS 10-K). Overall, Foot Locker

and its competitors disclose a healthy amount of information about their investing

activities as they relate to product differentiation. Foot Locker has made the largest

effort of the 3 firms to expand its brand into the “athleisure” segment that is currently

growing in popularity with its launch and expansion of SIX:02. Furthermore, Foot

Locker has made an enormous strategic effort to expand into the devoted runner

segment with its acquisition of Runners Point Group and its subsidiaries.

Conclusion

As described above, firms competing in the Athletic retail segment attempt to

achieve competitive advantages through investments in brand recognition, delivery

flexibility, and product diversification. Foot Locker provides sufficient disclosure into

their business activities as they relate to these success factors. Firms primarily compete

on the basis of brand equity and product variety, so it is important in the evaluation

process to be able to determine what activities took place and to what extent. It is

important for Foot Locker to provide such information, especially since it is the largest

store of its kind and has international operations. Foot Locker’s Type One accounting

policies are appropriately disclosed when compared with the industry.

Cost Cutting

Cost cutting is a way for the specialty sports shoes and apparel industry to

increase profits and maintain competitive advantage. With a low profit margin, cost

cutting in the industry is a key success factor because it helps to create greater profits.

Having a great distribution setup in the industry is also a very important cost cutting

strategy that reduces shipping cost. One of the main ways cost cutting efficiency is

determined in the industry is through comparing of the net income ratio. Another way

to determine cost cutting in the industry is through net sales to selling space ratio.

2009 2010 2011 2012 2013

Foot Locker (in thousands) Selling, General, and Administrative

Expense 1,332,000 1,516,000 1,796,000 2,034,000 2,133,000

Sales 4,854,000 5,049,000 5,623,000 6,182,000 6,505,000

SG&A to Sales ratio 0.27 0.30 0.32 0.33 0.33

Finish Line (in thousands) Selling, General, and Administrative

Expense 312,011 297,323 302,718 343,629 365,883

Sales 1,194,657 1,172,415 1,229,002 1,369,259 1,443,365


Dick's Sporting Goods (in thousands) Selling, General, and Administrative

Expense 972,025 1,129,293 1,148,268 1,297,413 1,386,315

Sales 4,412,835 4,871,492 5,211,802 5,836,119 6,213,173


As you can see in the chart above, the selling, general, and administrative

expense divided by the total sales results in a ration showing how each entity in the

industry compares in regards to cost cutting ability. The lower the ratio the more

efficient the company is at cost cutting.

Inventory control

Inventory control as a key success factor is the need for a specialty retailer to

efficiently manage the merchandise in their stores. Inventory control involves lead times

and the delivery process. The costs associated with these processes are partly included

in SG&A For 2013 but transportation, distribution center, and sourcing costs are

capitalized in merchandise inventory on the balance sheet. SG&A was 1,334, which is

an increase of 40 million from 2012 due to the recent Runners Point acquisition. As a

percentage of sales, SG&A was 20.9%, a low number compared to finish line’s 25.4% in

2013. Coming up with the value for merchandise inventory is not simple. Footlocker

uses what they describe on the 10-k as “the lower of cost or market using the retail

inventory method. Due to this convoluted method, measuring how effectively

management has been controlling their inventory is difficult, the best way to achieve

this looking at the inventory turnover ratio. As of 8/14 footlocker maintains a 3x

turnover ratio. This is relatively low compared to footlocker’s main competitor, finish

line, who’s current inventory turnover ratio is 4.2x. Finish line’s turnover may be better;

a healthy sign of efficiency, but their sales are not anywhere close to footlocker. As

stated in the 10-k, Footlocker order’s the bulk of their athletic footwear four to six

months prior to store delivery.

Fashion trends in the retail industry require delivery windows to be very

accurate, there is very little margin for error. Footlocker emphasizes their apprehension

of merchandise arriving too late or too early “Our failure to anticipate, identify or react

appropriately in a timely manner to changes in fashion trends that would make athletic

footwear or athletic and licensed apparel less attractive to these customers could have

a material adverse effect on our business, financial condition, and results of

operations.”, as this would require sales and discounts to sell their merchandise. Due to

the importance of timely delivery, footlocker uses distribution center to process and

regulate their retail merchandise. In 2013, as stated in the Properties portion of the 10-

k, Footlocker began operating two additional distribution centers. The new total is six

distribution centers, half of which are leased. These distribution centers, totaling 2.6

million sq. feet, help manage what they describe as “long lead times for ordering much

of our merchandise from vendors”. Although they distribute a lot of inventory

themselves they also depend on third-party carriers to transport a large portion of their

merchandise to their 3,500 stores.

Conclusion

As described above, firms competing in the Athletic retail segment attempt to

achieve competitive advantages through investments in brand recognition, delivery

flexibility, and product diversification. Foot Locker provides sufficient disclosure into

their business activities as they relate to these success factors. Firms primarily compete

on the basis of brand equity and product variety, so it is important in the evaluation

process to be able to determine what activities took place and to what extent. It is

important for Foot Locker to provide such information, especially since it is the largest

store of its kind and has international operations. Foot Locker’s Type One accounting

policies are appropriately disclosed when compared with the industry.

Type Two Key Accounting Policies

Goodwill is the perceived gain in value from the purchase of another company or

asset. This requires estimations of the real value of the assets. Whenever assets are

being estimated, overestimation can occur in order to make a balance sheet look more

attractive. Our does not amortize goodwill, but evaluates it for any impairment charges

based upon estimated future cash flows, and a market based approach. Due to the

estimation there is a high level of flexibility when managers are recording goodwill. In

the sector goodwill to assets has a large variance. This shows that management’s

evaluation of goodwill needs to be heavily picked apart in order to see if anyone is

skewing financial results.

net goodwill/ Assets

2009 2010 2011 2012 2013

Footlocker 5.04% 5.15% 5.01% 4.72% 4.31%

Finish Line N/A N/A N/A 1.20% 1.95%

Dicks Sporting 10.20% 8.93% 7.72% 6.69% 6.94%

Operating Leases

There are two kinds of leases, capital leases and operating leases. In a Capital

lease, some of the assets and liabilities of ownership are ascertained by the lessee.

In an operating lease, the lessee only assumes the right to use the property. The

property is returned to the lessor at the end of the lease period. When using an

operating lease the firm puts it as an expense on the income statement allowing it not

to affect the balance sheet. Operating leases are very common in athletic apparel and

footwear industry.

Operating Lease Obligations 2014 (in millions)

Company Name

Less than 1 Year

1-3 Years

3-5 years

More than 5 Years Total

Foot Locker 558 967 693 1,090 3,308

Finish Line 87 163 154 284 688

Dick's 798 908 1123 3,989 6818

The table shows the operating lease obligations for the 2014 athletic apparel and

footwear industry. This chart shows operating leases allow managers to keep these

numbers off over the balance sheet, thus giving them the ability skew information. The

numbers are so large they would have a significant impact on the financial status of

these companies. With the athletic apparel and footwear industry having such a high

level of operating leases, potential investors must convert these numbers into debt

equivalent, and calculate the interest that goes along with it. This allows investors to

accurately gauge a firm’s financial position.

Conclusion

By identifying the key accounting policies we can emphasize certain parts of

financial statements, and get a better understanding of the accounting used. Type one

accounting policies have to do specifically with industry wide success factors. These

accounting figures need to be analyzed across every business in our sector. Then there

are type two accounting policies. These include figures that management has

“flexibility” over. While analyzing type two policies, there can be times that figures are

purposely tampered with in order to show a better financial statement. For Foot Locker

this includes goodwill, and operating leases. All of these key accounting policies will

influence the perceived value of the business.

Potential Accounting Flexibility

The industry you are in has a lot to do with how flexible you can be with your

accounting in operations. GAAP is the set of accounting guidelines that must be

followed in the reporting process. This is the minimum requirement of what companies

must report in their financials. It can be good for the company or bad. For instance

Foot Locker Inc. can provide more than what is necessary which can give investors

more information to base their decisions on which can be good or bad depending on

what is reported.

Actual Accounting Strategy

The firms accounting strategy can be determined by considering two

components. First, you must determine whether the firm is a high disclosure firm vs.

low disclosure firm. GAAP (Generally Accepted Accounting Principles) sets the

requirements for the minimum information a firm must disclose. If a firm surpasses the

minimum information requirement, they would be considered a high disclosure firm.

Managers are the ones who decide how much information to disclose. The second

component when determining the actual accounting strategy, is conservative vs.

aggressive. In conservative accounting, understated financial performance is common.

This is because conservative accounting commonly undervalues investments.

Aggressive accounting uses techniques that overstate financial performance. Goodwill

and operating leases are what we will be looking at for Foot Locker Type Two

accounting policies.

Accounting for Operating Leases

It is much more beneficial for firms to use operating leases as opposed to capital

leases. Operating leases are a way for firms to keep the leases off the balance sheets

and instead put them on the income statement as an expense. Therefore, if a company

has a lot of operating leases like Foot Locker Inc. does then the financials can be

distorted to positively influence the appearance of their financials.

Accounting for Goodwill

Goodwill is an intangible asset that is incurred in the acquisition of an asset. This

allows firms to show added benefit that isn’t necessarily there. It can overstate a

company’s assets if it is not properly impaired. Foot Locker Inc. has Goodwill placed

under “Long Term Assets” in their 10-K. This means that Foot Locker Inc. wants to

show goodwill as a true asset of value instead of placing it under other assets. By

doing this Foot Locker Inc. uses aggressive accounting to positively influence their

financials.

Conclusion

The athletic shoe and apparel industry has a high level of disclosure in its

accounting policies. They give fair values for most the accounts on the balance sheet

and income statements.

Qualitative Analysis

A key factor to a financial analysis is the quality of disclosure that management

provides on their company. The better the quality of disclosure is, the easier it is to

make an accurate valuation. A firm’s management can distort the overall perception of

their company, as long as GAAP requirements are met, by deciding not to disclose

certain information. Through the manipulation of disclosure, the value of a company

can be greater than the actual value. It is important to keep in mind that management

can hide things from investors when considering trying to reach conclusions on a

company’s valuation. A red flag about the quality of disclosure when a company fails to

disclose all of the relevant information that investor’s might want to see. We

determined that the Footlocker’s quality of disclosure is weak.

Inventory Control

Properly managing inventory and its distribution is possibly the most important

factor relating to the success of a retailer. GAAP requires key items to be disclosed in a

company’s financial statements, but allows for several different methods in which to do

so. The relevant information needed to properly diagnose the performance of a firm’s

inventory control consists of three things: cost of goods sold, transportation costs, and

current inventory. Footlocker does a poor job of clearly disclosing these three cogs. In

their 10-k footlocker discloses cost of sales for 2013, but notes “Cost of sales is

comprised of the cost of merchandise, occupancy, buyers’ compensation, and shipping

and handling costs. The cost of merchandise is recorded net of amounts received from

vendors for damaged product returns, markdown allowances, and volume rebates, as

well as cooperative advertising reimbursements received in excess of specific,

incremental advertising expenses. Occupancy includes the amortization of amounts

received from landlords for tenant improvements.” Therefore cost of sales is a mixture

of many different things that some investors might not want to think of as such in their

analysis. The desired figure could be reached by an analyst calculating it themselves,

but footlocker failed to disaggregate cost of sales into a list of the inputs. This leaves

investors without an idea of what COGS or transportation costs actually were. The

merchandise inventory account is also disclosed with poor quality. This account should

represent the dollar value (whether market or cost) of inventory currently on hand.

According to the 10-k, “transportation, distribution center, and sourcing costs are

capitalized in merchandise inventories.” Again, Footlocker’s practices poor disclosure by

failing to list the inputs of an account that contains many key figures. This omission

costs the investors the ability to know exactly how much inventory is actually on hand.

Differentiation

At their core, the business models for all retailers are identical; buy a product from a

manufacturer and sell it to a consumer for more. In regards to merchandise, a specialty athletic

footwear and apparel retailer such as footlocker can offer almost nothing to a consumer that a

competitor cannot. Thus the logical conclusion is that footlocker must look somewhere else if

they wish to differentiate themselves and earn customers. The important figures to quantify

footlocker’s differentiation efforts are advertising expense and intangible asset acquisition costs

(mainly branding rights). For 2013 Footlocker lists an advertising expense of 102 million in their

10-k (net of cooperative reimbursements). For 2013, Footlocker lists an acquisition cost of 6

million (due to the runners point acquisition), which represents an amortized amount that will

continue for an undisclosed length of time. Overall, Footlocker discloses an adequate amount of

information in regards to differentiation.

Cost Cutting

For retailers, cost cutting is a never ending task and is a key factor for a firm’s

success. Selling, general, and administrative expenses is an item that contains a large

number of inputs. But in step with the theme Footlocker fails to list the figures from the

individual accounts that go into it. In their 10-k they do list that SG&A increased from

1,294 million in 2012 to 1,334 million in 2013. Almost 80% of FL’s employees work for

minimum wage and on top of that they have also been closing stores, (140 in 2013 to

be exact). This raises a red flag because an investor who might perceive an anomaly

would have no way of finding out why exactly SG&A increased. This is just an example

of Footlocker’s failure to expand on important items in their financials. We conclude that

footlocker’s quality of disclosure is poor when trying to evaluate cost cutting.

Conclusion

After evaluation the financials for footlocker and the accounting behind them, we

were left with more questions than answers. In conclusion, the quality of Footlocker’s

disclosure in their financial statements is poor. They fail to elaborate on numerous

items that might raise questions from investors. They exhibit accounting policies,

specifically for merchandise inventory, that in our opinion don’t represent the actual

values. We feel strongly that, while meeting GAAP standards, Footlocker fails to provide

adequate information to properly analyze the overall value of the company.

Identifying Potential Red Flags

Due to flexibility in accounting policies some management will misrepresent

information. Anytime this misrepresentation changes the perceived value of the firm, a

red flag is raised. After red flags have been established the analyst must go back to re-

evaluate them. This involves logical reasoning behind the change in value, than applies

it as a re-statement. Some common red flags include: (net sales/cash from sales), (net

sales/ inventory), asset turnover, (CFFO/OI), goodwill, etc. In the next section we will

determine from a list which parts of the financial statements should have a red flag.

Then we will decide if the red flags are big enough to need an adjustment.

Sales Manipulation Diagnostics Net Sales/ Cash from Sales

The net sales to cash ratio helps describe how much of sales are actually turned

into cash. If the company has a ratio under one than they could be recording extra

revenue that they can’t actually back with cash. If the ratio is over one than a company

might be have a hard time converting revenues into cash.

net sales/ Cash from sales 2009 2010 2011 2012 2013

Foot Locker N/A N/A N/A N/A N/A

Finish Line 1 1.001 0.994 0.999 1.004

Dicks Sporting 0.999 0.995 0.999 1.001 0.999

As you can see the ratio amongst competition is very steady around one, with

healthy fluctuations. Footlocker has shown to do a good job converting sales into cash

profits, this ratio does not show a red flag.

Net Sales/ Net Account Receivables

This ratio helps describe the proportion between sales and receivables. The

higher the number the better because it means they have turned a larger portion of

sales into earnings, rather than credit that some customers may not repay. When this

number is low an analyst must be weary of the company’s ability to collect revenue

net sales/ Net account receivable 2009 2010 2011 2012 2013

Foot Locker 98.81 131.19 123.15 114.76 90.91

Finish Line 155.06 308.42 115.94 152.11 97.5

Dicks sporting 71.45 124.63 139.17 136.06 168.67

Our industry has quite a wide range of numbers so consistency is important in

the analysis. It looks like Finish line has the biggest volatility problem with this ratio.

Dicks and Footlocker have ratios within the same range which could be due to close

size and sales numbers. Although Finish line would have a red flag and involve extra

analysis, Footlocker has shown consistency and a fair level of account receivables. No

concern is raised for Footlocker.

Net Sales/ Unearned Revenue

Management could use unearned revenue as a way to boost sales and improve

the appearance of the income statement. As this ratio gets closer to one it means that

more of the annual sales are actually unearned. This would require expenses later, but

improve the current year’s performance. A build-up of unearned revenue is a clear sign

of accounting tampering.

net sales/ unearned revenue 2009 2010 2011 2012 2013


Finish Line 23.01 29.3 35.42 45.48 53.05

Dicks Sporting 40.14 40.78 39.99 40.46 39.86

The specialty retail industry does not have a large amount of unearned revenue.

When most customers make purchases it would be a direct exchange of goods. Our

industry does not show any signs of misrepresentation. Footlocker particularly does not

show any unearned revenue on its statements so there are no red flags associated with

the accounting.

Net Sales/ Inventory

This ratio describes the amount of sales that come from inventory. Companies

are expected to grow inventory with sales in order to meet demand growth. Inventory

accounting methods will be very important in giving inventory a value.

net sales/ inventory 2009 2010 2011 2012 2013

Foot Locker 4.09 4.33 4.87 5.31 5.78

Finish Line 4.45 4.9 6.44 7.07 6.55

Dicks Sporting 4.65 5.16 5.44 5.81 5.75

It appears that the industry is steadily growing near the same rate, although we

would expect inventory levels to stay around the same increase as sales. While

reviewing Footlockers 10-K they state that inventory levels could be wrong, “ The RIM

is a system of averages that requires management’s estimates and assumptions

regarding markups, markdowns and shrink, among others, and as such, could result in

distortions of inventory amounts” This raises a red flag and will include more in depth

analysis to fully understand inventory amounts.

Core Expense Manipulation Diagnostics

Cash Flow from Operations/ Net Operating Assets

By analyzing if cash flows from operations are supported by net operating assets

this ratio is used to test for potential expense manipulation. If a firm’s ratio increased

significantly and then decreased significantly, this would call for a potential red flag.

CFFO/NOA 2009 2010 2011 2012 2013

Foot Locker 0.89 0.85 1.16 0.85 0.9

Finish Line 0.34 1.16 0.86 0.75 0.45

Dicks Sporting 0.31 0.61 0.57 0.53 0.52

In the table above, Foot Locker’s numbers do not have any substantial increase

or decrease. Since Foot Locker numbers are not out of the ordinary, there is no reason

to raise any concern.

Cash Flow from Operations/ Operating Income

The cash flow from operations to operating income is used to test for potential

expense manipulation. If a firm’s ratio remains consistent over a substantial period of

time it means cash flows from operations support the operating income that is stated

on the income statement, and there is no reason for concern.

CFFO/OI 2009 2010 2011 2012 2013

Foot Locker 4.7 1.27 1.14 0.68 0.8

Finish Line 1.19 2.19 0.99 0.71 0.73

Dicks Sporting 5.26 1.78 1.26 0.95 0.84

In the table above, Foot Locker’s numbers do fluctuate quite a bit, meaning

there might be a potential red flag.

Asset Turnover

This ratio involves dividing net sales by total assets. The ability to turn the same

proportion of assets into more sales will help create a competitive advantage. It also

measures how reasonable a company has stated assets on the balance sheet.

The chart shows very consistent levels amongst the industry. The narrow range

of 1.7 – 2.1 means that the specialty retail industry earns around two times its assets.

If there were any materially large outliers than there would be reason for concern.

Since Footlocker stays well within this range there are no red flags.

Undo Accounting Distortions

Once the accounting analysis is complete and the red flags have been identified

then a true value can be determined for each flag. If the true value of these accounts

can materially affect the users view than a restatement is used. As more distortions are

taken out of the statements, greater transparency and comparability results.

Footlockers red flags include the ratio of cash flows from operations to net income,

inventory costing, and operating leases.

If cash flow from operations isn’t near operating income, than there are sales

that don’t match up to cash. The reason we red flagged Footlocker for this was an

instability in ratios. In 2009 Footlocker had a ratio of 4.7 which is extremely high; then

by 2012 it was .68. After careful analysis Footlocker’s 2013 balance sheet and income

statement will be unchanged. This is because over the last few years the industry’s

ratios have leveled out and been somewhat consistent around healthy levels.

Inventory accounting is very flexible. This can cause miss-statements especially

since inventory makes up a large amount of the retail industries assets. As stated earlier

Footlocker management uses certain inventory accounting methods to determine

inventory. In the 10-K management states “Cost of sales is comprised of the cost of

merchandise, occupancy, buyers’ compensation, and shipping and handling costs.” In

the retail industry merchandise is inventory, so clearly footlocker is including more in

inventory than just products. After calculating the extra costs associated with inventory

we found that there is only a 2% decrease in the inventory account. Because the value

does not change by much it is unnecessary to include a restatement for inventory.

The last red flag to check is the most common one for high operating lease

industries. Since these leases are so large management will capitalize them in order to

keep it off the balance sheet. But as stated in 10-K “the Company includes the present

value of operating lease commitments in total net debt.” (FL 10-K). Usually a company

capitalizes the operating leases to take them off the balance sheet, but because

footlocker simply moved it to another account called total net debt there will not be a

miss-representation on the financial statements. Re-stating Footlockers operating leases

is unnecessary and does not need to be accounted for.

Overall Footlocker has shown transparency throughout their financial accounting

and given fair values for each account. They are also good at disclosing important

figures such as discount rates. Because of the overall accuracy of Footlockers financial

statements no re-statements will be required to analyze the firm.

Financial Statement Analysis

An important step in placing the value on a company is ratio analysis. This

involves interpreting past the information from the financial statements to analyze

variables such as company structure, profitability, trends, as well as relative

performance to competitors, and other information useful in estimating intrinsic value.

Footlocker will be analyzed based upon liquidity, operating efficiency, profitability, and

capital structure.

Liquidity Ratios

Liquidity ratios are used to determine if a firm has the ability to pay liabilities

using current assets or cash. Firms must have a certain level of liquidity in order to pay

off accounts and many other reasons. If a company does not have enough liquidity

they may be forced to sell off assets at a large discount in order to pay off their expiring

liabilities. A high level of liquidity is also good for firms because it allows firms to

borrow money from lenders at a lower interest rate. The two liquidity ratios we will

looking at are current ratio and quick asset ratio. Using these ratios we can better

understand Foot Locker Inc.’s liquidity.

Current Ratio

The current ratio is calculated by dividing current assets by current liabilities to

determine how liquid a firm is. Current ratio is one of the most used ratios in

determining liquidity. Although current ratio is not always completely right when it

comes to judging a firm’s liquidity, it does a pretty good job. A current ratio of under

one means that a firm has more current liabilities than it does current assets, indicating

it likely might not have enough funds to cover its expiring liabilities. A ratio of greater

than one means the firm probably has the liquidity to pay its expiring liabilities which is

what creditors and potential lenders prefer.

In the athletic shoe and apparel industry pretty constant relative to each other.

In regards to the industry, Foot Locker Inc. is an industry leader in regards to current

ratios. A higher current ratio is always what a company strives for and Foot Locker Inc.

has surpassed the industry average every year for the past six years. Having a high

current ratio isn’t always a good thing though, having a high current ratio can indicate

that a firm isn’t investing their assets correctly. But, the amount in which Foot Locker

Inc. is above the industry is not large enough gap to be problematic. After analyzing

the current ratio for the industry, it is clear that Foot Locker Inc. surpasses the industry

average and keeps a sufficient level of liquidity.

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Current Ratio Foot Locker

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Quick Asset Ratio

The quick asset ratio only includes the most liquid of a firm’s assets including

short term investments, cash, and accounts receivable. The assets, like in the current

ratio, are divided by current liabilities. The main difference in current ratio and quick

current ratio is the use of inventory in the calculation because although inventory is a

current asset, it is only as liquid as the firm’s ability to sell that inventory. A ratio of

more than one is preferred like in the current asset ratio but having a ratio of below

one for quick asset ratio is not necessarily a bad thing because inventory is often a

large part of a firms currents assets. Therefore, quick asset ratio is only includes a

firms most liquid assets and gives a more conservative liquidity measure than the

current asset ratio.

Foot Locker’s quick asset ratio indicates that they have been above

industry average for the past 6 years. When looking at the graph you can see that Foot

Locker has maintained a steady quick asset ratio where Finish Line had a large spike in

2011 and has been falling ever since. Foot Locker’s quick asset ratio is relatively high

and has been steady rising since 2009. The large differentiation is not unexpected

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Quick Ratio

Foot Locker

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when looking at the quick asset ratio because a large part of the industry’s assets are

inventory which is one of the largest asset accounts for these firms. This means that

Foot Locker might be holding too much inventory. They were the industry leaders in

current ratio but are second when it comes to quick asset ratio. This means that when

inventory is removed for the quick asset ratio calculations Foot Locker falls in the

rankings. Therefore, this shows Foot Locker is probably holding too much inventory.

Overall, Foot Locker maintains a very acceptable quick asset ratio and does not appear

to have any liquidity problems.

Liquidity Ratio Conclusion

When comparing Foot Locker’s ratios to other firms in the industry, Foot Locker

seems to be above industry average and has sufficient liquidity. Foot Locker and Finish

Line both lead the pack with ratios much above industry average while Dicks has the

lowest liquidity ratios of the industry across the board. Both the quick asset and

current ratios are volatile because of a spike around 2011 between all firms and then

falling back down in 2014 to similar ratios as in 2009. In conclusion, Foot Locker is one

of the industry leaders in regards to liquidity ratios.

Operating Efficiency

Operating Efficiency decreases waste and boosts resource capabilities (ratios are

shown by relating input and outputs.) Operational efficiency is defined by Wikipedia “as

the ratio between the input to run a business operation and the output gained from the

business.” They show how much a company gets out of what they put in.

Inventory Turnover

Inventory turnover is a ratio that shows the number of times the inventory in

stock for a company is sold and replaced during specific period of time. This ratio is

calculated by sales divided by inventory. A higher ratio is better because it represents a

higher level of sales. A lower ratio shows that company has too much inventory. Over

the past five years, Foot Locker’s inventory turnover has been slightly increasing. This

is a good thing because it means that Foot Locker has been increasing sales and

efficiently handling their inventory.

The chart above shows the inventory turnover for Foot Locker, its competitors

and the industry average. As you can see from the chart Foot Locker is below the

industry average. All three of the companies’ inventory turnover is very close. But unlike

the industry average and the other companies, Foot Locker’s inventory turnover is up

from the previous year from 5.3 to 5.33.

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Inventory Turnover

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Working Capital Turnover

The working capital turnover ratio compares the decrease of working capital to

the sales of a specific period. This is calculated by dividing sales by working capital. This

ratio is used to evaluate the link between money spent to fund operations and sales

generated from operations. It is good when the working capital turnover is higher

rather than lower. A higher ratio means the company has more sales compared to the

amount of money that they used to create the sales. Over the past five years, Foot

Locker’s working capital turnover has had relatively no change.

The chart above shows Foot Locker, its competitors and the industry average

working capital turnover. As you can see Foot Locker and Finish Line are significantly

below the industry average. Over the past six years Foot Locker’s working capital has

been about the same. For Foot Locker to improve their ratio they will need to be more

strategic in how the use money to generate sales.

Day’s Supply Inventory

This ratio helps explain how efficient management is with inventory. By taking

365 days and dividing it by inventory turnover were given the amount of time inventory

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sits in supply. By having inventory on shelves for shorter periods of time, storage costs

can be lowered and less spoilage will occur. On the other hand the shorter the

inventory is on shelves the more likely you are to run out. It is a balancing act by

managers to figure out which level is efficient for their company.

Although footlocker had the highest DSI of 78 since 2009, management has

consistently improved DSI to match industry standards of 68. Day’s supply inventory is

strongly related to inventory turnover, which is influenced by different inventory levels.

The reason Foot Locker and Dick’s are higher than the industry could be because higher

inventory levels, whereas Finish Line has smaller inventory levels which would make

DSI easier to control. It is a good sign that Foot locker has been consistently lowering

DSI to the industry standard while maintaining larger inventory levels.

Day’s Payable Outstanding

This ratio shows the average amount of days it takes to pay accounts payable to

its creditors. When this number is low than the creditors will be happy and likely reissue

payables. When this number is very low than the company could be taking advantage

of discounts on accounts payable. Keeping (DPO) low could even hurt the company by

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preventing them from using the cash in other ways before the debt was due. Finally,

with a high DPO creditors might get upset and quit issuing the debt which could cause

financing problems for the future. This is also an important balancing act to figure out

which ratio amount is the most valuable for their company.

Footlocker has a lower days payable outstanding than the Industry average. This

could be a good sign if they are taking advantage of discounts from payables. Normally

a discount comes if paid before a few days not 20, but not all payables have discounts

and don’t reward quick payments. This creates a positive outlook on Footlocker, but

may not be too influential on the valuations.

Days Sales Outstanding (DSO)

The day’s sales outstanding ratio is the average number of days that it takes a

company collect revenue after sales have been made. This is calculated by accounts

receivable over total credit sales multiplied by number of days. A high days sales

outstanding means it takes a company a high number of days to collect their revenue. A

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Days Payable Outstanding

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low day’s sales outstanding means it takes a low number of days to collect. Intern

having a low days sales outstanding is preferable. Foot Locker does not have any

accounts receivable so we are unable to calculate day’s sales outstanding.

Cash to Cash Cycle (CCC)

The cash to cash cycle shows the number days it takes a company to convert

input resource input into cash flows. The CCC is calculated by day’s inventory

outstanding plus days sales outstanding then subtract day’s payable outstanding. The

CCC measures the time each input dollar is used in production before it becomes cash

again through sales. The less time it takes for a company to convert an input dollar to a

sales dollar the better. Foot Locker’s cash to cash cycle had been declining over the

past six years.

The chart above shows the cash to cash cycle for Foot Locker, its competitors

and the industry average. As you can see above over the past 6 years Foot Locker’s

cash to cash cycle is significantly higher than both the industry average and its

competitors. Although is higher, it has declined by over 22%. This means that Foot

Locker’s money that they input is coming out as sales quicker.

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Operating Efficiency Ratio Analysis Conclusion

When looking at Foot Locker’s ratios compared to their competitors and the

industry average, Foot Locker is slightly behind in operating efficiency. Foot Locker is a

tiny bit behind in most of the ratios and on par with others. One area that needs the

most improvement is working capital turnover. They have been below the industry

average for the past six years. Foot Locker’s efficiency when using working capital

needs to increase to better the sales numbers. As stated above Foot Locker is slightly

behind or on par with all but one of the operating efficiency ratios. The chart below

shows all of the ratios compared to their competition.

Operating Efficiency Ratios Performance Trend

Inventory Turnover Average Improving

Working Capital Turnover Underperforming Improving

Days Supply Inventory Average Declining

Days Payable Outstanding Outperforming Declining

Days Sales Oustanding N/A N/A

Cash to Cash Cycle Underperforming Improving

Profitability Ratios

Profitability ratios show how profitable a firm is at taking net sales and turning

them into net income. Finding profits can easy be found by looking at firm’s 10-K but

the ratios can help investors see actual profitability in a firm. When valuing a firm,

profitability ratios are crucial for identifying earnings and profit trends for the firm.

Profitability ratios are also analyzed when forecasting a firm’s financials. The ratios we

will be looking at are gross profit margin, operating expense margin, operating profit

margin, net profit margin, asset turnover, return on assets, and return on equity. The

footwear and apparel industry is highly competitive with firms trying to control cost and

have reasonable margins to ensure success.

Gross Profit Margin

Gross profit margin states the gross profit of a company as a percentage of net

sales. The gross profit margin is calculated by taking revenue minus cost of goods sold

and then dividing that by revenue. A higher percentage means a company is keeping

cost of goods sold low compared to relative to net sales. When analyzing margins it is

important to compare them to the industry because although a margin can seem either

high or low, it could be on point with the industry which is what really matters. This is

true because there are no real target margins for all companies. The margin differs

from industry to industry depending on what they sell. In the apparel and shoe

industry the gross profit margin is relatively low due to products being widely available

and there being little differentiation between firms.

After looking at the gross profit margin it is apparent that Foot Locker is below

the industry average over the past 6 years. This means that Foot Locker’s cost of

goods sold is higher than that of competitors on a percentage basis. This shows that

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Foot Locker might be not be handling their inventory efficiently. In the athletic shoe

and apparel industry profits are achieved through high sales instead of marking up

prices. For Foot Locker to improve their profitability they need to manage their cost of

products more efficiently.

Operating Expense Margin

Operating expense margin is a measure of what it cost to operate an

establishment compared to the income the establishment brings in. Operating expense

margin is calculated by taking operating expense and dividing it by gross operating

income. Operating expense margin allows potential investors to see if a certain

expense is higher than others comparted to others. Therefore, they can compare

potential efficiency. The higher the margin is the more expenses there are.

Foot Locker is an industry leader when it comes to operating expense margin.

This means that Foot Locker is able to able to minimize their expenses in regards to

operations. They are maintaining a lower operating expense than the income they

receive from the operations. Foot Locker is efficiently running their operations above

industry average.

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Operating Profit Margin

The operating profit margin is calculated by taking operating income and dividing

it by sales. Operating income is calculated by taking gross profit and subtracting out

general, selling, and administrative expenses. The operating profit margin is a good

measure in analyzing how efficient a firm is in regards to expenses. To show high

profitability a firm wants to have a high operating profit margin which in turn means the

firm is keeping their selling, general, and administrative expenses low.

The operating profit margin for Foot Locker is well below the industry average

from 2009 thru 2012 and from 2013 to current they have surpassed the industry to

become the industry leader. Foot Locker was the lowest in the industry for several

years but has increased their sales by diversifying their product line and reaching a

broader consumer base. Therefore, Foot Locker has become an industry leader,

surpassing the industry average.

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Net Profit Margin

Net profit margin may be one of the most important margins analyzed when

trying to determine how profitable a company is. The net profit margin is calculated by

taking net sales and dividing it by net income. Net profit margin is useful because it

directly relates sales and income and from that investors can determine how profitable

the company is. If the margin is high then in turn, the profits are high.

The industry had similar net profit margins from 2009 to 2012 with a steady

increase. In 2013 when the rest of the industry had lower net profit margins, Foot

Locker kept climbing to become the industry leader for the past two years. This shows

that Foot Locker has managed to manage their expenses better than their competitors

in recent years. The industry uses a large amount of operating leases which can also

mess up net profit margin. After analysis it is clear that Foot Locker has surpassed the

industry and is now the industry leader in profitability.

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Asset Turnover

The asset turnover ratio is great because it links the balance sheet and the

income statement which is quite useful when trying to forecast a firms financial

statements. It also links total sales and total assets which is important as well. Asset

turnover ratio is calculated by taking revenues (or sales) and dividing it by total assets.

The asset turnover ratio in simpler terms means how much the firm is selling for every

dollar worth of assets they have. This ratio is considered a lag ratio which means that

sales are generated from assets that the firm already owns. This also means that in

order to calculate it you must use the assets from the previous year are used to

calculate the currents year’s ratio.

Foot Locker’s asset turnover ratio is the lowest in the industry for the past 6

years. This means that Foot Locker has made poor use of their pre-existing assets to

generate sales. Foot Locker’s asset turnover was between 1.7 and 2.0 for the past 6

years which roughly means that there are $1.80 of sales produced by each dollar of

asset. One thing that hurts Foot Locker’s asset turnover is the fact that they capitalize

leases which otherwise would be a huge asset for them. Therefore, raising their asset

turnover ratio. Overall, Foot Locker’s asset turnover is below industry average but it is

-

0.50

1.00

1.50

2.00

2.50

2010 2011 2012 2013 2014

Asset Turnover

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Industry

by no means bad. They still manage to keep competitive even though they are below

industry average.

Return on Assets

This ratio helps explain the profits produced from assets. ROA is like asset

turnover but instead of putting net sales in the numerator they use profits. Assets are

the resources a company has to produce profits. These assets are funded through

equity and leverage so the ability to efficiently use these resources is what creates sales

and profits. It is easy to make profits off a lot of money, but making the most profits off

the least amount of money is what ROA measure.

Return on assets is pretty steady throughout the industry. Foot Locker was last

in the industry for several years but since 2013 they boosted their returns and became

the industry leader. The steady increase over the past 6 years is a good sign for Foot

Locker. This means that they have become much more efficient at turning their assets

into profit which is a very good thing. This means that although they were not always

the leader they have worked through their problems to become the industry leader in

return on assets.

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2009 2010 2011 2012 2013 2014

Return on Assets

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Industry

Return on Equity

This is a ratio that explains the profits produced from owners’ equity; Calculated

as net income divided by owners’ equity. This is a good test of management because

their jobs are to raise shareholders wealth by reinvesting in the firm.

Foot Locker is right on track with Finish Line’s return on equity and is also the

lowest in the industry even though it has been steadily rising over the past 6 years.

Foot Locker has gotten better with return on equity and is currently above the industry

average in 2014 but not by much. The graph shows that Foot Locker has gotten much

better over the past 6 years on turning a profit on their equity.

Profitability Ratios Conclusion

The profitability ratios for Foot Locker showed that they are mostly

underperforming against the industry. Although their ratios weren’t always the best in

the industry they are by no means doing badly. They are consistently leading the

industry and in most cases have an improving margin over the past 6 years. When

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2009 2010 2011 2012 2013 2014

Return on Equity

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Industry

looking at net profit margin and return on assets, Foot Locker was underperforming

against the industry between 2009 thru 2012 and then surpassed the industry to

become the leader from 2013 to current. Foot Locker was able to surpass the industry

by diversifying their product lines by acquiring more subsidiaries and therefore increase

their customer base. Overall, Foot Locker is staying competitive in the industry in

regards to profitability.

Profitability Ratios

Analysis Performance Trend

Gross Profit Margin Underperforming Consistent

Operating Expense

Margin Underperforming Declining

Operating Profit Margin Average Increasing

Net Profit Margin Average Increasing

Asset Turnover Underperforming Consistent

Return on Assets Average Increasing

Return on Equity Underperforming Increasing

Internal Growth Rate

The internal growth rate is the rate that a firm can grow without being financed

at all from any outside activities. Meaning the company must rely independently on its

operations in order to expand. This is calculated by multiplying the return on assets by

the plowback rate. The higher the IGR the more potential a company has to grow

without changing its underlying form and process. Also the higher the IGR the higher

the returns will be whenever an equal amount of leverage is established.

Internal Growth

Rate 2009 2010 2011 2012 2013 2014

Foot Locker 0.5% 5.0% 9.0% 12.4% 15.0% 15.7%

Finish Line 1.2% 6.9% 11.6% 13.4% 11.8% 11.0%

Dick's Sporting

Goods -2.0% 6.0% 7.0% 10.8% 20.7% 13.1%

Industry

-

0.43% 6.48% 9.33% 12.11% 16.27% 12.03%

The industry’s internal growth rate (IGR) has been very close over the past five

years. This should be true of an industry with similar products and high competition

especially when all forms of leverage are taken out of the equation. Recently, there has

been a decline in IGR while footlocker managed to slightly increase. It appears as if the

IGR is finding the market average since the recession and it’s a good sign to see less

volatility in footlocker than the industry. The high IGR also indicates that Foot Locker

can increase sales without outside financing which is a huge advantage in the industry.

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2009 2010 2011 2012 2013 2014


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Industry

Sustainable Growth Rate

Sustainable growth rate (SGR) is return on equity times the plowback rate. This

means that no leverage adjustments are made from its current financing system, in

other words no debt or equity can be added on to what it currently uses. If a company

wants to grow faster than the SGR than they must take out additional debt to leverage

better gains.

Sustainable Growth

Rate 2009 2010 2011 2012 2013 2014

Foot Locker 0.2% 2.2% 3.9% 5.5% 6.3% 6.2%

Finish Line 0.5% 2.6% 4.1% 4.6% 4.0% 4.5%

Dick's Sporting Goods -2.4% 6.5% 6.3% 9.0% 17.0% 10.7%

Industry

-

0.97% 4.55% 5.25% 6.82% 10.47% 7.60%

This chart looks similar to the change in debt to equity of each company. SGR

takes into account the growth rate if the current capital structure existed but didn’t

change. Since footlockers capital structure barely changes they experience a more

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

2009 2010 2011 2012 2013 2014


Foot Locker

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Industry

consistent SGR, whereas Dick’s debt to equity is constantly changing so it will have a

more volatile SGR over time. Although Footlocker has a lower than industry SGR, it

might be due to consistency in capital structure and is better correlated with the retail

industry as a whole.

Capital Structure

Capital structure refers to the way in which a company is funded. This can

influence the company’s liabilities, interest expenses, EPS, and many other fundamental

accounts. Leverage and interest are the biggest concerns with capital structure.

Leverage can increase volatility in profits/losses, and interest takes cash out of the

company without adding any value. The balancing act between liabilities and equity is

important in determining a company’s long term profitability, and value.

Debt to Equity

This ratio is used to determine how much of the company’s assets are funded by

debt or equity. A ratio over 1 means more debt is being used to fund the company. This

is usually followed by high leverage, larger volatility, and higher interest expenses. If a

company can effectively use this leverage than the higher volatility will lead to

magnified profits, or vice versa magnified losses. On the other hand a debt to equity

ratio under 1 means the company is being funded by investors. This may be preferred

because there should be less interest expense, and more liabilities are in the hand of

shareholders who aren’t guaranteed money under liquidation. It is preferred to not be

to funded by debt in order to save margins from interest expense, so a Debt/Equity of

1.3 would be a reasonable cap to maintain long term

Footlocker has a high satisfactory level of debt to equity. The managers have

maintained their capital structure with the lowest volatility in the industry. By having

lower levels of debt there is less interest expense for the company. In the retail industry

with cost cutting as a success factor, having lower levels of interest is important. This is

a great sign and will have a positive influence on value.

Times Interest Earned

Times interest earned is especially useful for companies funded by debt. The

number it gives describes the dollar amount of operating income made for each dollar

amount of interest expense. When a company has more interest expense than it can

even earn in profits than it won’t be long till they file for bankruptcy. When the number

goes under one it would be reasonably impossible for a firm to find a way to create

enough profits to stay in business. A business would need a ratio much higher than 1 in

order to make any real returns, so a large coverage is required for a quality investment.

A ratio of 2 means 50% of profits are instantly lost to interest; A ratio of 20 means 5%

of profits are instantly lost to interest. A minimum ratio of 10 would be the lowest an

investment grade company could maintain without giving up to much of its profits.

-

0.20

0.40

0.60

0.80

1.00

1.20

1.40

2009 2010 2011 2012 2013 2014

Debt to Equity

Foot Locker

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Industry

Compared to the industry Footlocker has had the lowest times interest earned.

This is not a good sign as it eats into the profits of the company. Finish line has no

interest expense so it is irrelevant in the industry. This could be due to low leverage,

and Footlocker could improve by creating better profits off more debt. Although it is low

and unfavorable, it has consistently increased since 2009 and could keep improving.

Debt service margin

Debt service margin describes how well a company can pay off the annual

principle portion of long term debt with its annual operating cash flows. Operating cash

flows play an important role in the repayment of long term debts, because continual

profits through operations should be the core cash generator of the business. Cash

earned through investing or financing is not a normal part of business, and can’t be

expected to fund debt over the long term without raising liabilities. A value over 1 is

absolutely required, but a cushion is needed to create long term profits. A number over

5 would be the lowest reasonable rate a company could operate with.

-50

0

50

100

150

200

2009 2010 2011 2012 2013 2014


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Industry

Footlocker has had a cyclical improvement of debt service margin. We would like

to see a higher number than the industry average, but footlocker seems to consistently

earn better profit margins. The industry as a whole has been shifting its debt to equity

so that could be the reason behind the volatility while footlocker stayed consistent.

Footlocker has held a lower debt service margin than the industry.

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00

200.00

2009 2010 2011 2012 2013 2014

Debt Service Margin

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Altman Z score

The Altman Z score measures the likeliness of a company going bankrupt. A

score below 1.3 means that a company is headed towards bankruptcy, a score over 3 is

an unlikely chance of the company going bankrupt any times soon (Investopedia). This

score is a measure consisting mainly of asset based ratio’s which can inform banks

about creditworthiness, and investors about investment quality in equity or bonds. The

Altman Z score equation is as follows:

1.2(working capital/total assets) +

1.4(retained earnings/total assets) +

3.3(earnings before interest and taxes/total assets) +

0.6(market value of equity/book value of total liabilities) +

1(asset turnover ratio)

= Altman's Z-Score

The industries z-scores have ranged quite a bit in the past 5 years. Foot lockers

Altman z-score has improved the most from 3.7 to 7.3 and recently risen about the

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

2009 2010 2011 2012 2013 2014

Altman's Z-Score

Foot Locker

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Industry

industry average. A good sign is that even after the recession in 2008 Footlocker and

the industry all still remained optimistic 3 and above z-scores. Footlocker shows

favorably, and creditors and investors are likely to loan money to them. It is very

unlikely that footlocker will go bankrupt.

Capital Structure Analysis Conclusion

Capital structure measures how the company’s assets are financed, either

through liabilities or equity. Management has done a good job of controlling capital

structure and staying consistent over the years. Most of the company is funded through

equity which is a good sign of investor involvement. But footlocker has more trouble

covering its debt expenses than the industry averages. Overall the capital structure is

very stable, and is slowly moving towards industry averages.

Capital structure ratio

analysis

Ratio performance Trend

Debt to Equity over-perform consistent

Times Interest Earned under-perform improving

Debt Service Margin under-perform improving

Altman Z-Score average improving

overall average improving

Financial Forecasting

To accurately value footlocker’s intrinsic value we must first forecast the financial

statements. Forecasts must be as realistic as possible because small mistakes can make

big differences. This is the cornerstone of the valuation process and thus must be done

with the upmost precision. Our forecasts project the three financial statements over the

next 10 years; a seemingly futile exercise that is made possible through the analysis of

key financial ratios. Using historical trends, economic predictions, and ratio analysis we

are able to make assumptions and forecast the balance sheet, income statement, and

statement of cash flows for the next 10 years.

Income Statement

The first financial statement to forecast is the income statement. This is the most

important part of the process because the balance sheet and cash flows are affected by

this. The driver of the income statement forecasting is the projected sales. After

analyzing historical trends of both footlocker and our industry, we chose a sales growth

of 6.5%. This is a conservative number that we feel confident is a realistic assumption.

After finding the projected sales we are able to predict the gross profit using the

average gross profit margin for the last 5 years. Once finding gross profit cost of goods

sold is reached by using simple addition and subtraction. The next step is to predict

SG&A, which we did by using the average operating expense margin for the last 5

years. Once we have operating income the next step is to find net income. We did this

by calculating the average net profit margin for the last 3 years, which is a percentage

of the total sales. After predicting net income the next step is to move on to the

balance sheet.

Balance Sheet

Following the income statement predictions the next step is to forecast the

balance sheet. To do this we must predict what assets, liabilities, and equity will be for

the next 10 years. The best financial ratio to link the income statement and balance

sheet is the asset turnover ratio. After careful analysis of historical trends we decided

on an asset turnover ratio of 1.8. This gives us total assets based on a percentage of

sales. Once we found our projected total assets we were able to find the totals for

noncurrent and current assets using the common size balance sheet. Current assets

was found by simply calculating the average percentage of current assets to total assets

for the last 5 years and multiplying it by the projected total assets for the current year.

After current assets were found we simply used the difference between that and total

assets for the noncurrent assets.

Next we must find equity and liability. We know the total of liability and equity

will equal assets, but finding the weight of each is difficult. We started by predicting

retained earnings. We did this by adding the retained earnings of the previous year with

net income of the current year as well as dividends paid. Projecting dividends is a

difficult thing to do. We started by assuming no share buy backs or new issuances. We

then projected a dividend growth rate. Footlocker has seen their dividends grow rapidly,

as much as 12.8% in 2013, but after careful analysis we decided on a rate that was

constantly decreasing by .3% year to year. This gave us our total equity. We then

simply subtracted total equity from our liabilities and equity to reach our total liabilities.

We used our common sized report to further break down total liabilities the same way

as we did with total assets.

Cash Flow Statement

The final projection to make is that of the cash flow statement. This statement

has three parts, cash flows from operating, investing, and financing. First we were able

to project the net change in cash by simply subtracting forecasted cash for the current

from the previous, which we had forecasted earlier on the balance sheet. Next we

projected cash flows from operations. The top line is net income, which we had already

forecasted; the next step was to find cash flows from operation which we did by

multiplying net income by the average ratio of CFFO to net income from the last 5

years, a relatively simple step. Next we found cash flows from financing by using the

dividend projections we previously calculated and adding them with the projected debt

repayment, a negligible number we felt confident in assuming. After finding the cash

flows from investing we were able to find the cash flows from financing. This was done

by adding the cash flows from operating and financing activities and subtracting them

from our net change in cash.

Cost of Debt

The cost of debt is the effective interest rate paid for all liabilities. Items such as

preferred stock which could be considered interest bearing are not included in the cost

of debt. Since there are so many interest rates being used for various forms of debt it is

useful for forecasting, and analyzing management’s ability to control interest expense.

This can be done with a before and after tax rate which is helpful since interest expense

can be deductible.

Interest

bearing debt

(2014)

Amount (in

millions)

interest

rate source weight WACD

Current

Liabilities:

accounts

payable

298.00 0.02% 3 month T bill

0.30 0.01%

other current

liabilities

338.00 0.02% 3 month T bill

0.34 0.01%

Non-Current

Liabilities:

Long-Term

Debt

133.00 8.50%

FL's 10-K under : long term

debt

0.13 1.14%

other Non-

Current

Liabilities

196.00

2.53% 10 year T bill

0.20 0.50%

pension plan 25 6.24%

FL's 10-K under: Pension and

Post-retirement liabilities

0.03 0.16%

Total

990.00

1.00 1.81%

An important part variable in finding the weighted average cost of debt is the

varying interest rates used. All of the interest rates used were found in the 10-K and

any that aren’t were based off the US Treasury bill. The accounts payables and other

current liabilities section did not list any kind of interest expense, but with all forms of

debt there will be some minute charges of interest. With the non-current liabilities

section we will start to find larger interest rates to fund the debt. It is specifically stated

in Footlockers 10-K that the debenture rate on long term debt is 8.5%. Other non-

current liabilities had multiple sub sections disclosed in footnotes these include:

straight-line rent liability, income taxes, deferred taxes, postretirement benefits,

workers compensation, pension, and other. Out of all of these sub categories pension

was the only account with a given interest expense, so it has been adjusted out of non-

current liabilities and given its own rate. For the rest of the non-current liabilities the 10

year T bill rate was used in order to account for all maturities of debt at a risk free rate.

The combination of these interest rates weigh together to form a weighted average cost

of debt of 1.81%.

The other variable involved with finding the weighted average cost of capital is

the weights given. This is found by dividing the liabilities account value by the total

liabilities on the balance sheet. As you can see most of the weight is given to current

liabilities (64%), which has the lowest rates. Low interest rates don’t influence the

WACD more than .02% so they are not as important. The non-current portions of debt

only make up 36% of liabilities, but due to higher interest rates they are more

influential over the WACD. The long term debt makes up 1.79% of the weighted

average cost of debt showing that most interest expense comes from long term debt.

Weighted

Average Cost of

Debt (Restated)

Interest bearing

debt (2014)

Amount (in

millions)

interest

rate source weight WACD

Current

Liabilities:

accounts payable 298 0.02% 3 month T bill 0.301 0.01%

other current

liabilities 338 0.02% 3 month T bill 0.3414 0.01%

Non-Current

Liabilities:

Long-Term Debt 130.51 8.50% FL's 10-K under : long term debt 0.1318 1.12%

Capitalized

operating leases 2.49 8.65% 0.0025 0.02%

other Non-

Current Liabilities 196 2.53% 10 year T bill 0.198 0.50%

pension plan 25 6.24% FL's 10-K under: Pension and Post-

retirement liabilities 0.0253 0.16%

Total 990 1 1.81%

In order to restate the WACD we must capitalize the operating leases out of long

term debt. After doing so there is not much change because of how they currently

account for operating leases. In Footlockers 10-K they disclose that the capitalized

operating leases are accounted for in long-term debt. When we add the capitalized

lease account we have to take the same amount out of long term debt, so liabilities are

unchanged. Also the interest rates are very similar which is why restated WACD isn’t

changed.

Cost of Capital

The cost of capital for a firm calculates a single discount rate for all debt and

equity capital that the business holds. This rate is used to discount the firm’s financials

in order to estimate the value of the firm’s assets. The Weighted Average Cost of

Capital (WACC) is a weighted average of the costs associated with debt and equity

capital. The weights and averages represent the fractions of all debt and equity capital

in the business. In the following sections Foot Locker’s WACC will be estimated using

these debt and equity components.

Cost of Equity (Ke)

The cost of equity can be computed using the Capital Asset Pricing Model. The

CAPM calculates an expected return that the market requires for ownership stake in any

given company by using variable related to the market and the company. The

systematic risk (Beta), the risk free rate of return (Rf), and a premium over the market

return (Rm-Rf), known as the Market Risk Premium. The cost of equity is commonly

referred to as the return on equity, and this represents the return that investors require

for their invested dollars. The CAPM equation is:

Ke = Rf + B (Rm – Rf)

For our analysis, we ran a regression to test the stability of the systematic risk

(Beta) attributed to our firm for 72, 60, 48, 36, and 24 month holding periods by using

the 3 month, 1, 2, 7, and 10 year Treasury Bond Yield. These notes represent the risk

free return and were supplied to us by the St. Louis Federal Reserve database. The risk

free returns were given on an annual basis for each month, and were converted to a

monthly yield for consistency as we ran the regressions. The market returns were

calculated using historical prices of the S&P 500. The market risk premium (MRP) is

calculated as the market return minus the risk free return. This represents the excess

return investors expect when taking on additional risk associated with the market,

known as beta risk. Due to the recent stimulus and intentional grounding of interest

rates, market risk premiums are very low. For o`ur analysis, we have chosen a MRP of

4%. Academic research indicates that these changes to the current economy place the

MRP between 3-4%, which is the basis for our chosen risk premium (Palepu).

As mentioned previously, Beta represents the correlation of firm specific risk with

the overall market. Firms with Beta of 1 are perfectly correlated with market, meaning

those firms move in sync with changes to market returns. Betas of less than 1 indicate

a firm’s returns are less correlated with the market, and subsequently Betas of greater

than imply that those firm’s returns are more sensitive to market movement (Palepu).

By using historical market data, we were able to track the overall stability of Foot

Locker’s Beta by conducting regression analysis. The regressions were calculated using

historical company and market returns using MRPs associated with different Treasury

yield maturities on a monthly return basis. The regression table below shows estimated

Betas with a lower and upper bound Beta based on a 95% confidence interval, meaning

that we are 95% confident that Beta will be within a given range. Using the 10 year

Treasury bill regression, we obtained a Beta of 1.13 with a lower bound of .65 and

upper bound of 1.60. As of October 31, 2014, Yahoo Finance estimates a Foot Locker

Beta of 1.03. This Beta is well within our confidence interval and shows us that analysts

feel Foot Locker’s performance and systematic risk is moving near perfectly with the

broader market. The Adjusted R² is a percentage measure of systematic risk, also

shown in the tables provided.

The table above shows each regression relative to the different Treasury bill

maturities. The adjusted R² for the 72 .month 10 year regression is 22.92%, meaning

23% of the risk adjusted return for Foot Locker can be explained by the market,

otherwise known as explanatory power. For our purposes, we will use this R² as a

representation when computing our WACC.

The Ke is calculated using the CAPM model mentioned above, and is estimated to

be 7.04%. This is our implied ROE for Foot Locker based upon our regression analysis.

It is worth noting that the traditional CAPM adjusts returns for their systematic risk, but

fails to address the question of firm size, also known as the “size effect”. Historically,

smaller firms have returned greater than larger firms. This suggests that the relative

size of a company matters when estimating the cost of capital (Palepu). The above

table calculates a size adjusted return using a size premium, which is estimated based

on the market value of equity for firms within that range. We have taken the average

size premium for firms between the 3-7 billion dollar market capitalizations, shown

above to be 1%. This gives us a size adjusted cost of equity to be 8.04% with a lower

and upper bound Ke of 6.13% and 9.95%, respectively. These estimates along with

those for the Kd will be used to calculate our WACC.

Alternative Cost of Equity Method

The traditional approach to estimating the cost of equity uses historical data,

however there is a “back door” method for estimating the cost of equity. The

Alternative Cost of Equity estimation uses the current Price to Book ratio as well growth

predictions for the return on equity in order to solve for the cost of equity (Ke). The

formula is represented as:

P/B = 1 + (ROE – Ke) / (Ke – g)

The formula uses the current Price to Book ratio, the forecasted average Return

on Equity, and the geometric average growth in equity over the next 10 years. Since

forecasted data is used to run this formula, a forecasted balance sheet and income

statement are used indirectly. For this reason, we will compute the alternative Ke on an

as-stated basis.

The table above shows our backdoor cost of equity to be 6.05% which falls right

outside of our lower bound Ke of 6.13%.

Weighted Average Cost of Capital

The WACC is the weighted average cost of funds employed by firms in order to

run the business and generate returns. This also represents the weighted average

return that investor’s expect from their respective investment in the company itself. The

WACC equation attempts to solve for this expected return by taking the market value of

liabilities and the market value of equity and then multiplying each by its assumed costs

necessary to attain those funds, known as the cost of debt (for liabilities) and the cost

of equity (for shareholder’s equity). Once the weighted average is computed for

liabilities and equity, the two are added together to give us the WACC. There are before

tax and after tax implications for each:

WACCbt = (MVL/MVF)*Kd + (MVE/MVF)*Ke

WACCat = ((MVL/MVF)*Kd) * (1 – Tax Rate) + ((MVE/MVF)*Ke)

The table above calculates the WACC on a as-stated basis. The Market Value of

the firm’s assets must first be calculated using the market value of liabilities and equity.

The market value of equity, often referred to as the market cap, is equal to the firm’s

number of shares outstanding for given period of time multiplied by the share price at

that time as well. According to Yahoo Finance, the number of shares outstanding was

145.43 million shares outstanding at a price of $41.71 on February 1, 2014. The market

value of liabilities is all debt liabilities that are interest bearing. These were taken from

Foot Locker’s 10-K at year end 2013, and were estimated to be $990 million. These

market values of debt and equity are then added together to give us the market value

of the firm’s assets. This is important because when finding the WACC, the cost of

capital is found by denominating both equity and liabilities by the firm’s assets. This

makes sense since Assets are equal to Liabilities plus Equity. Since we are attempting to

find the essential cost of funds that are used to procure all assets, we only account for

the interest bearing debt involved. After finding a before-tax and after-tax WACC, our

estimated cost of capital is around 7.12%.

Operating leases are capitalized and included in net debt, according to the FL

10-K. After conducting our own present value estimation of operating leases, the

amount to be taken from long term debt was not material in estimating our weighted

averages. As a result, the cost of capital was unchanged and a restated WACC was not

necessary for our valuation. Below, we have used a 95% confidence interval for the

lower and upper bound range of the WACC as it changes with the lower and upper

bound costs of equity previously discussed. This will give us a better idea of where our

WACC should be within the given range.

Shown above are the upper and lower bound estimates for the WACC. From

these tables we can expect the true WACC to lie somewhere within this range. The as-

stated WACC was found to be about 7.12%, which was computed by taking the

average of the before-tax and after-tax costs of capital. As you can see, this cost of

capital lies well within the 95% confidence interval. Going forward, we will use the as-

stated WACC for our valuation technique, since the restatement of operating leases did

not have a marginal effect on our estimations.

Methods of Comparables

By using comparables we determine a stock price to help us value the company.

Having a well performing company is not a good investment if you have to pay more

money for the actual returns on the investment. Using these will compare certain

metrics to the current stock price and help obtain a “determined price”. The market

value on similar assets should be relatively close. With the retail industry being highly

competitive the methods of comparables should give us close industry average ratios.

The downside to using comparables is they only account for one year of information, so

ratios can be skewed.

Since the derived values will not be exact with our stock price we will set a %

range from the current price to determine whether or not the price is under or

overvalued. We have established ourselves as 10% analysts at a current price of

$56.10, therefore a “derived price” under 50.49 is overvalued and any price over 61.71

we consider Footlocker to be undervalued. All of our ratios will come from the share

price on October 31, of $56.10 and be computed based upon the (10-K) of each

company for the year ending 2013.

Trailing P/E

The trailing price to earnings ratio uses the previous 12 months earnings per

share and the current share price. This ratio uses previous earnings instead of

predicted earnings. This makes for a more reliable measure. To calculate Foot Locker’s

value we used the EPS and multiplied it by the industry average.

Trailing P/E

Share Price

Trailing 12 Month EPS

Trailing P/E

Industry Average Comparable

Company

Foot Locker Inc. 56.10 3.36 16.70 16.37 55.00

Finish Line 26.47 1.71 15.48 27.99

Dick's 45.37 2.68 16.93 43.87

The trailing P/E industry average was calculated to be 16.37. Using their EPS we

can conclude that Foot Locker has an average price of 55.00. In accordance with our

10% analyst position and the October 31st observed stock price of 56.10, the trailing

P/E comparable shows that Foot Locker Inc. is fairly valued.

Forward P/E

The forward price to earnings ratio is similar to trailing P/E but instead of uses

forecasted earnings per share rather than previous earnings. This ratio is very

dependent on how accurate the forecasted financials are. The forward P/E comparable

can help determine stock price based on future predictions of earning per a share.

P/E Forward

Share Price

Estimated EPS

P/E Forward2

Industry Average Comparable

Company Foot Locker

Inc. 56.10 3.83 14.65 14.52 55.59

Finish Line 26.47 1.93 13.73 27.99

Dick's 45.37 2.99 15.17 43.42

The industry average for the forward P/E was computed to be 14.52. Foot

Locker’s forward P/E is very close to the industry average. From this information we

can determine Foot Locker’s stock price to be 55.59. Using our 10% analyst position

we can conclude that Foot Locker is fairly valued.

Dividend to Price

The dividend to price ratio is calculated by taking a firm’s dividend per share and

dividing it by the share price. A high dividend to price ratio compared to the industry

usually suggests that a company is undervalued. We can calculate a new share price for

footlocker by dividing their dividend per share by the industry average dividend to price

ratio.

Dividend to price PPS DPS D/P

Industry avg. Comparable

Company Footlocker PPS

Footlocker 56.10 0.86 0.0153 0.0116 74.23

Finish line 26.40 0.32 0.0121

Dick's 45.25 0.50 0.0110

Footlocker has a high dividend to price ratio .0153, compared to the industry

average of .0116. This resulted in a higher new price per share. The new share price of

$74.23, compared to their actual share price of $56.10, means that in regards to

dividend payout, footlocker is undervalued.

Price to Book

The price to book ratio is calculate by dividing the current price per share by the

book value of equity. We can arrive at a share price for footlocker by multiplying the

book value per share by the industry average price to book ratio. Footlocker’s price to

book is relatively high for the industry which usually indicates that a company is

overvalued.

Price to Book PPS BPS P/B Industry avg. Comparable

Company Footlocker PPS

Footlocker 56.10 17.86 3.14 2.66 8.34

Finish line 26.40 12.44 2.12

Dick's 45.25 14.18 3.19

The average price to book ratio for the industry was calculated as 2.6567. After

multiplying this with footlocker’s book value per share we arrive at a price per share of

8.34. This combine with their high price to book ratio suggests that footlocker is

overvalued.

P.E.G Ratio

The P.E.G. ratio is found by the price to earnings ratio divided by the 5 year

average growth rate in earnings. Taking the P.E.G. industry average and multiplying it

by the five year growth rate and Foot Locker’s earnings per share will show the average

price per share.

Price Earnings Growth (PEG) P.E.G.

Industry Avg. Comparable

Company

Foot Locker's PPS

Foot Locker 1.39 1.49 60.71

Dick's Sporting Goods 1.36

Finish Line 1.61

As seen the in the table above, the industry average is 1.49. Foot Locker’s P.E.G.

is below the industry average. Based on the P.E.G. ratio it would suggest Foot Locker is

undervalued. We calculated Foot Locker’s price per share as stated at 60.71 which

would make Foot Locker slightly undervalued. Since is we are +/-10% analyst the 60.71

is not more than 10%, we have concluded that Foot Locker is fairly valued based on the

P.E.G. ratio.

EV/EBITDA

This ratio is calculated by the firm’s enterprise value (EV) over the firm’s EBITDA.

Enterprise value is calculated by market cap plus debt, minority interest and preferred

shares, minus total cash and cash equivalents. EBITDA is earning before interest, taxes,

amortization and depreciation. EBITDA shows the profitability a firm has with the

effects of financing and accounting decisions left out.

Enterprise Value to EBITDA EV/EBITDA

Industry Avg. Comparable

Company Brinker's PPS

Foot Locker 8.14 7.55 47.62

Dick's Sporting Goods 8.34

Finish Line 6.76

As shown in the above table, Foot Locker’s EV/EDITDA is slightly more than the

industry average. After calculating Foot Locker’s price per share as stated, you can see

47.62 is significantly lower than 56.1. Based on Foot Locker’s EV/EDITDA, Foot Locker’s

price per share is overvalued.

Price / Free Cash Flow

This model helps value a company by comparing the current price by the free

cash flow earned by each share. Free cash flow is calculated by adding or subtracting

cash flow from investing activities from the cash flow of operating activities. Outliers

commonly exists due to the volatility of the free cash flow from year to year. While a

company can have consistent operating cash flow, a year that has expansion can lead

investing activities to be abnormally high causing FCF to be low.

Price to FCF market cap

free cash flow

shares outstanding

P/FCF

Industry average

Comparable

Footlocker

8,173,770,000

282,000,000

145,700,000 29.0 69.1 134

Dicks 5,791,000,0

00 64,695,00

0 89.5

Finish Line

1,350,000,000

27,767,000 48.6

As you can see the Footlocker has a P/FCF that is much lower than the industry average

of 69.1. This is a good sign because it means we are paying less for each free cash

inflow. To get our comparable price we divide FCF by shares outstanding to get FCF per

share, we than multiply the number to get 134. The large difference between

footlocker and the industry will lead to a significantly undervalued current price.

Price / EBITDA

The price/EBITDA model helps value a company by dividing the price per share

by earnings before interest, taxes, depreciation, and amortization. By taking these extra

factors out we can measure how much an investor pays for the earnings before paying

for these normal business operating expenses.

Price to EBITDA market cap EBITDA

shares outstanding P/EBITDA

Industry average Comparable

Company

Footlocker 8,173,770,000 797,000,000 145,700,000 10.256 8.54 46.71

Dicks 5,791,000,000 691,740,000 8.372

Finish Line 1,350,000,000 155,069,000 8.706

In order to obtain a dollar of EBITDA from footlocker you must invest more money than

in their competitors. With an industry average of 8.54 and multiplying by an EBITDA per

share of 5.47; based upon our 10% analyst valuation footlocker would appear to be

overvalued with a comparable price of 46.71.

Intrinsic valuation models

Through the use of intrinsic valuation models we can more precisely find a value

for Footlocker. The models used are more accurate for a few reasons; they use

historical data instead of just one year, it incorporates the cost of capital in the model,

and takes into account time value of money. Five of these valuation models will be

used: discounted dividend, discounted free cash flow, residual income, long run residual

income, and abnormal earnings growth. After creating these models we will have a

good guidance as to how Footlocker is valued.

When the models are completed we can then use sensitivity analysis to get a

better understanding of what drives value. By changing variables we can test the limits

of a firm and see when they are valuable, and when they are not. We can then use

these multiple variables as adjustments for our forecasting. Since we are established as

10% analysts based upon the share price of 56.1 we will consider a valuation under

50.49 to be overvalued and a valuation above 61.71 to be undervalued. These models

combined with our comparables prices will ultimately determine whether or not our

company is worth buying or selling.

Discounted Dividends Model

The discounted divided valuation model estimates the stock value by discounting

future dividend payments through our regression analysis. This model almost always

shows that firms are overvalued because it does not account for growth from retained

earning not paid in dividends. It is often uncommon for firms to pay little or no

dividends and once the payouts are discounted back to present value, it is common for

dividend stream to be insignificant or nonexistent. This model is also flawed because it

assumes dividends will be paid at a constant rate, when in reality they are often the

same payments for a period of time before the firm decides to change dividend

payouts. This results in the dividend growth resembling a flight of stairs and not a

straight line. It is important for the firm to focus on the current value of the firm in

order for the model to explanatory power. Forecast are less reliable in the long term so

it is important to correctly value the firm at current prices when using this model.

First, we take the forecasted dividends per share from 2014 to 2023. The

forecasted statement of cash flows has forecasted annual dividend payout through

2023. For this model the shares outstanding is help constant. Then to find the

forecasted dividends per share we divided the annual dividend payout by the shares

outstanding. Then individual payments are discounted back to present value and the

dividend stream through 2023 has been calculated. The other part of the model

forecast from 2023 to infinity. Using year 11 forecasted dividends we are able to

calculate year 10 perpetuity. Then, using estimated cost of equity, we the year 10

perpetuity back to present value. Both present values from the two inputs are added to

get the implied model price for Foot Locker. We are now able to compare the observed

share price of $56.10 to our model price. We can now use the chart below to using the

sensitivity analysis the different growth rate and cost of equity values.

g

Ke

Foot Locker's Discounted Dividend Sensitivity Analysis

0.00% 3.88% 6.91% 7.88% 9.88%

-10% 40.55 25.99 19.78 18.30 15.80

-20% 27.86 20.44 16.60 15.61 13.87

-30% 23.64 18.16 15.14 14.35 12.90

-40% 21.52 16.92 14.31 13.61 12.33

-50% 20.25 16.15 13.77 13.12 11.94

OV UV < 0 FV

When applying out 10% analyst position to Foot Locker discounted dividends

sensitivity analysis, Foot Locker is overvalued in every situation. The highest price

derived from the sensitivity analysis was $40.55 at a growth rate of 0% and at cost of

capital of -10%. This value is far below the observed share price of Foot Locker

meaning that Foot Locker is greatly overvalued. For this model to show Foot Locker as

fairly valued Foot Locker would need to increase cost of capital and decrease their

perpetuity growth rate. This model uses unpredictable inputs to suggest that Foot

Locker is overvalued and for that reason we can conclude that this model does not give

an accurate assumption of Foot Locker’s true value.

Discounted Free Cash Flows

The discounted free cash flow model unlike the discounted dividend model, it

takes into account the cash that is generated by the firm and provides more

explanatory power. Forecasting cash flows is difficult therefore most of the time this

model has a high degree of forecasting error. To calculate Foot Locker’s year to year

free cash flow, cash flows from investing activities are subtracted for cash flows from

operations for the 10 years that it is forecasted. These are discounted back to present

value by using the weighted average cost of capital before tax. Avoiding double taxation

is important. Like the discounted dividend model, free cash flow model uses the PV of

the year to year cash flows from year 11 to infinity. This is also used for the 10 years

prior.

g

As soon as the year to year present vales and the cash flows from perpetuity are

included, the results are the Foot Locker’s market value of assets. Market Value of

equity over number of shares outstanding results in the implied model price. The

implied price multiplied by the 9 month FV factor allows us to get the time consistent

price. Lastly, a sensitivity analysis must be used to allow you to see the different values

related to the different before tax weighted average cost of capital and perpetuity

growth rates.

17.81 0% 6.26% 7.17% 8.26% 9.26%

-10%

17.81

17.81

17.81

17.81

17.81

-20%

17.81

17.81

17.81

17.81

17.81

-30%

17.81

17.81

17.81

17.81

17.81

-40%

17.81

17.81

17.81

17.81

17.81

-50%

17.81

17.81

17.81

17.81

17.81

OV UV <0 Fair V

As you can see above, Foot Locker is shown as overvalued.

AEG Model

The AEG model bases forecasted figures with a benchmarked value. The

forecasted figures include net income, and dividends paid. The AEG model is closely

related to the residual income model has a high level of explanatory power, and is a

good measure of a firm’s intrinsic value. This model discounts under a constant

WACC

perpetuity based upon the firms cost of equity. The main difference between this model

and the residual income model is that growth is accounted for in the numerator of the

equation and keeps Ke constant in the denominator.

To begin calculating AEG we need to first find the normal earnings benchmark by

taking last year’s earnings and growing it by the cost of capital. The next step is

figuring out the cumulative dividends by using net income and dividends reinvest

earnings (DRIP). Then to find the AEG you subtract the benchmark income from the

actual income. After this you use the cost of equity to find the present value for each

AEG than add them up to get a total. Next you determine the terminal value which is

the forward AEG divided by Ke minus the growth rate. Then you add these two

numbers to get the adjusted AEG. After obtaining the adjusted AEG you add it to the

benchmark net income, and divide the results by shares outstanding for a per share

value. This final per share value is divided by the cost of capital to derive our intrinsic

value on a per share basis.

The spreadsheet below shows the sensitivity analysis for our AEG model and the

different intrinsic values. The variable on the vertical axis is growth and the horizontal

axis uses the cost of equity. The numbers in the chart represent the time consistent

prices.

Ke

0% 3.88% 6.91% 7.88% 9.88%

-10% $ 62.91 $ 39.29 $ 39.29 $ 27.14 $ 23.24

g -20% $ 45.37 $ 32.32 $ 32.32 $ 24.09 $ 21.16

-30% $ 39.52 $ 29.46 $ 29.46 $ 22.65 $ 20.13

-40% $ 36.59 $ 27.91 $ 27.91 $ 21.82 $ 19.51

-50% $ 34.84 $ 26.93 $ 26.93 $ 21.27 $ 19.10

overvalued > 50.49 > Fairly valued < 61.71 < undervalued

g

Based upon our AEG sensitivity analysis most of our numbers are overvalued.

The only point where our time consistent price is undervalued is when Ke is 0%. This

model is heavily weighted on Ke since the price drops faster as this number rises. As

10% analysts these results show that Footlocker is extremely overvalued. This will be

weighted heavily when deciding the overall value of Footlocker.

Residual Income Model

The residual income model has high explanatory power. Residual income is what

is left after accounting for opportunity cost of capital. It is the most useful method out

of the applied models. The residual income model is the most accurate for a couple of

reasons. Firstly, if it doesn’t react as strongly to a change in the growth rate as the

other models. Secondly, year by year inputs hold more weight than the perpetuity. A

logical method seeing as short term forecasts can be estimated much more accurately

than horizon value forecasts. The most accurate way to make an accurate model is with

accurate inputs. Based on a declining trend in footlocker’s residual income we chose to

use a value at -30% of Foot lockers 2024 residual income for the perpetuity amount.

Ke

The residual income model resulted in footlocker being consistently overstated.

The minimum cost of equity of 0% shows that only a 10% and 20% result in a number

that would suggest footlocker being undervalued. Therefore it is safe to say that out

residual income model suggests that Foot locker is overvalued.

Long Run Residual Income Model

This model is related to residual income in the belief that residual income

destroys or adds to the book value of equity. To begin this model we must start with

our market value of equity by adding the residual income to the book value of equity.

This model uses variables from both income statement and balance sheet which adds to

its degree of explanatory power. The equation for MVE is shown below.

The whole point of this model is to account for three variables at a time. After

calculating the MVE you simply divide by the shares outstanding than do a sensitivity

analysis to adjust the variables influencing the value. These three inputs include the

growth rate, cost of equity, and return on equity, and one will be held constant. The

long run residual income models are shown below.

g

$56.01 -10% -20% -30% -40% -50%

4% 36.66 28.76 25.51 23.73 22.62 Constant ROE 19%

Ke 6% 32.6 26.98 24.48 23.07 22.16

8% 29.43 25.44 23.55 22.45 21.73

10% 26.89 23.11 22.72 21.89 21.33

12% 24.82 22.95 21.97 21.36 20.95


ROE

$56.01 15% 17% 19% 21% 23%

4% 23.43 24.47 25.51 26.55 27.59 Constant g -30%

6% 22.48 23.48 24.48 25.48 26.48

Ke 8% 21.63 22.59 23.55 24.51 25.48

10% 20.87 21.79 22.72 23.65 24.58

12% 20.17 21.07 21.97 22.86 23.76


ROE

$56.01 15% 17% 19% 21% 23%

-10% 25.37 27.4 29.43 31.46 33.49

-20% 22.83 24.14 25.44 26.75 28.05 Constant ke 8.00%

G -30% 21.63 22.59 23.55 24.51 25.48

-40% 20.93 21.69 22.45 23.21 23.97

-50% 20.47 21.1 21.73 22.36 22.99


Show by the long run residual income model, and most other valuation models

Footlocker appears to be overvalued. The closest Footlocker gets to becoming fairly

valued is when ROE was held at the constant 19%, this was due to a low cost of equity

and growth rate. Re-iterating from our models before Footlocker is an overvalued

company.

Final Recommendation

To fully analyze a company the first step involves an industry analysis, and what

makes a firm successful over the competition. The competition for this analysis included

Dicks Sporting Goods (DKS) and Finish Line (FINL). The best way to measure a

company’s relative performance is with porter’s five forces, which helped us understand

how Footlocker fits in the economic world and how it compared to competitors.

After exploring the sports retail industry we can start to take a look at each

specific companies key accounting figures to see if management is miscuing numbers to

look better. Most of Footlockers finances were reasonably stated. The major problem

with retail companies is the capitalization of operating leases, but because Footlocker

included those obligations into long term debt no restatements were required. Since

management has proven that it will fairly report all parts of the business we deem the

company to be transparent.

Finally to determine our recommendation we must piece together all forms of

research, financial ratios, comparable, and valuation models to reach an intrinsic value.

Based upon the intrinsic value and the current share price we can consider the current

price to be either undervalued, fairly valued, or overvalued. Based upon a October 31st

price of 56.1 and being 10% analysts our valuation models all showed that footlocker is

largely overvalued, even with its good financial ratio comparisons over competitors.

Based on our analysis we recommend stock holders

2009 2010 2011 2012 2013

Foot Locker (in thousands) Selling, General, and

Administrative Expense 1,332,000 1,516,000 1,796,000 2,034,000 2,133,000

Sales 4,854,000 5,049,000 5,623,000 6,182,000 6,505,000


Finish Line (in thousands) Selling, General, and

Administrative Expense 312,011 297,323 302,718 343,629 365,883

Sales 1,194,657 1,172,415 1,229,002 1,369,259 1,443,365


Dick's Sporting Goods (in thousands)

Selling, General, and Administrative Expense 972,025 1,129,293 1,148,268 1,297,413 1,386,315

Sales 4,412,835 4,871,492 5,211,802 5,836,119 6,213,173


net goodwill/ Assets

2009 2010 2011 2012 2013

Footlocker 5.04% 5.15% 5.01% 4.72% 4.31%

Finish Line N/A N/A N/A 1.20% 1.95%

Dicks Sporting 10.20% 8.93% 7.72% 6.69% 6.94%

Operating Lease Obligations 2014 (in millions)

Company Name

Less than 1 Year

1-3 Years

3-5 years

More than 5 Years Total

Foot Locker 558 967 693 1,090 3,308

Finish Line 87 163 154 284 688

Dick's 798 908 1123 3,989 6818

net sales/ Cash from sales 2009 2010 2011 2012 2013


Finish Line 1 1.001 0.994 0.999 1.004

Dicks Sporting 0.999 0.995 0.999 1.001 0.999

net sales/ Net account receivable 2009 2010 2011 2012 2013

Foot Locker 98.81 131.19 123.15 114.76 90.91

Finish Line 155.06 308.42 115.94 152.11 97.5

Dicks sporting 71.45 124.63 139.17 136.06 168.67

net sales/ unearned revenue 2009 2010 2011 2012 2013


Finish Line 23.01 29.3 35.42 45.48 53.05

Dicks Sporting 40.14 40.78 39.99 40.46 39.86

net sales/ inventory 2009 2010 2011 2012 2013

Foot Locker 4.09 4.33 4.87 5.31 5.78

Finish Line 4.45 4.9 6.44 7.07 6.55

Dicks Sporting 4.65 5.16 5.44 5.81 5.75

CFFO/NOA 2009 2010 2011 2012 2013

Foot Locker 0.89 0.85 1.16 0.85 0.9

Finish Line 0.34 1.16 0.86 0.75 0.45

Dicks Sporting 0.31 0.61 0.57 0.53 0.52

CFFO/OI 2009 2010 2011 2012 2013

Foot Locker 4.7 1.27 1.14 0.68 0.8

Finish Line 1.19 2.19 0.99 0.71 0.73

Dicks Sporting 5.26 1.78 1.26 0.95 0.84

-

0.50

1.00

1.50

2.00

2.50

3.00

2009 2010 2011 2012 2013 2014

Quick Ratio

Foot Locker

Finish Line

Dick's SportingGoods

Industry

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

2009 2010 2011 2012 2013 2014

Inventory Turnover

Foot Locker

Finish Line


Industry

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

2009 2010 2011 2012 2013 2014

Current Ratio Foot Locker

Finish Line

Dicks SportingGoods

Industry

-

2.00

4.00

6.00

8.00

10.00

12.00

2009 2010 2011 2012 2013 2014


Foot Locker

Finish Line


Industry

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

2009 2010 2011 2012 2013 2014

Days Supply Inventory

Foot Locker

Finish Line


Industry

0.0

10.0

20.0

30.0

40.0

50.0

60.0

2009 2010 2011 2012 2013 2014

Days Payable Outstanding

Foot Locker

Finish Line


Industry

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

2009 2010 2011 2012 2013 2014

Cash to Cash Cycle

Foot Locker

Finish Line


Industry

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

2009 2010 2011 2012 2013 2014

Gross Profit Margin

Foot Locker

Finish Line


Industry

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

2009 2010 2011 2012 2013 2014


Foot Locker

Finish Line


Industry

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

2009 2010 2011 2012 2013 2014

Net Profit Margin

Foot Locker

Finish Line


Industry

-

0.50

1.00

1.50

2.00

2.50

2010 2011 2012 2013 2014

Asset Turnover

Foot Locker

Finish Line


Industry

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

2009 2010 2011 2012 2013 2014


Foot Locker

Finish Line


Industry

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2009 2010 2011 2012 2013 2014

Return on Assets

Foot Locker

Finish Line


Industry

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2009 2010 2011 2012 2013 2014

Return on Equity

Foot Locker

Finish Line


Industry

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2009 2010 2011 2012 2013 2014


Foot Locker

Finish Line


Industry

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

2009 2010 2011 2012 2013 2014


Foot Locker

Finish Line


Industry

-

0.20

0.40

0.60

0.80

1.00

1.20

1.40

2009 2010 2011 2012 2013 2014

Debt to Equity

Foot Locker

Finish Line


Industry

-50

0

50

100

150

200

2009 2010 2011 2012 2013 2014


Foot Locker

Finish Line


Industry

0.00

50.00

100.00

150.00

200.00

2009 2010 2011 2012 2013 2014

Debt Service Margin

Foot Locker

Finish Line


Industry

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

2009 2010 2011 2012 2013 2014

Altman's Z-Score

Foot Locker

Finish Line


Industry

Interest bearing debt (2014)

Amount (in

millions) interest rate source

weigh

t

WAC

D

Current Liabilities:

accounts payable

298.00 0.02% 3 month T bill

0.30

0.01

%

other current liabilities

338.00 0.02% 3 month T bill

0.34

0.01

%

Non-Current Liabilities:

Long-Term Debt

133.00 8.50%

FL's 10-K under : long

term debt

0.13

1.14

%

other Non-Current Liabilities

196.00 2.53% 10 year T bill

0.20

0.50

%

pension plan 25 6.24%

FL's 10-K under: Pension

and Post-retirement

liabilities

0.03

0.16

%

Total

990.00

1.00

1.81

%

Weighted Average Cost of Debt (Restated)

Interest bearing debt (2014)

Amount

(in

millions)

interest

rate source weight

WAC

D

Current Liabilities:

accounts payable 298 0.02% 3 month T bill 0.301 0.01

%

other current liabilities 338 0.02% 3 month T bill 0.3414 0.01

%

Non-Current Liabilities:

Long-Term Debt 130.51 8.50% FL's 10-K under : long term debt 0.1318 1.12

%

Capitalized operating

leases 2.49 8.65% 0.0025 0.02%

Works Cited

https://www.census.gov/retail/

http://www.sec.gov/

http://finance.yahoo.com/

http://www.footlocker-inc.com/investors

http://strategiccfo.com/

http://phx.corporate-ir.net/phoenix.zhtml?c=132215&p=irol-reportsannual

http://www.footlocker-inc.com/pdf/2008/AnnualReport2008.pdf

https://www.census.gov/retail/

http://www.sec.gov/

http://finance.yahoo.com/

http://www.footlocker-inc.com/investors

http://strategiccfo.com/

http://phx.corporate-ir.net/phoenix.zhtml?c=132215&p=irol-reportsannual

http://www.footlocker-inc.com/pdf/2008/AnnualReport2008.pdf

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