Ticker Reports for May 31^st

Foot Locker’s Quarter Sends Doubters Running

After reporting its first quarter 2024 financial results, shares of Foot Locker Inc. (NYSE: FL) jumped by as much as 40% as markets reacted to what could be the retail sector’s latest turnaround story. Now that the stock is consolidating to the end of the week, investors can use this breather to hop on a new thesis for Foot Locker stock.

This thesis centers on management’s plan to turn things around and deliver even better bottom-line results, among many other points. After a challenging past couple of years, the U.S. consumer may finally be on a comeback, which is why bulls had no problem ripping up Foot Locker stock after earnings.

But before investors dig into the company’s results and what they mean for the stock’s future, it would be helpful to understand where the economy could be headed, particularly the trends affecting consumer discretionary stocks. Even if Foot Locker does well, it still has to overcome potentially negative sentiment around its peers.

Financial Strength of Foot Locker Underpins Analyst Optimism

After contracting for four months straight, U.S. consumer sentiment readings have finally expanded, crystalizing what could be the bottoming for retail stocks like Foot Locker. In this fashion, investors can have a couple of catalysts to lean on.

First, the ISM manufacturing PMI index showed three consecutive months of expansion for the apparel industry, increasing the upside-tail risk for stocks inside it to report better-than-expected earnings or at least optimistic outlooks for the rest of the year.

Sentiment and business activity may have been aided by the prospect of interest rate cuts later this year, which, according to the CME’s FedWatch tool, could be here as soon as September 2024.

Airline stocks could act as a proxy for future consumption, as analysts recently upgraded United Airlines Holdings Inc. (NASDAQ: UAL) after the Transportation Security Administration (TSA) reported a new record 2.9 million passengers in a single day.

What’s the next most common spending item for consumers after travel? That’s right, apparel. Foot Locker investors know this, and analysts weren’t afraid to take this view.

Wall Street wants to see up to 43.8% earnings per share (EPS) growth for Foot Locker in the next 12 months, beating those at peers like Nike Inc. (NYSE: NKE) with its 5.9% growth projections for the year.

Why would analysts stick their necks out in such a bullish projection for Foot Locker? Here’s where the company’s financials come into play.

A Mixed First Quarter for Foot Locker With a Deep Message

While comparable sales, the retail sector’s primary key performance indicator (KPI), declined by 1.8% over the year, other metrics indicate the company’s resilient efficiency.

Accounts payable in the company’s cash flow statement rose by roughly $170 million, typically meaning the company is looking to increase inventory while delaying payment to its suppliers.

That can be taken as a good sign for higher demand, where analyst projections come to fruition. Now that the stock has traded down to 73% of its 52-week high, despite its recent rally, valuations have become more critical.

Foot Locker stock trades at a roughly 20% discount to its book value, as suggested by its 0.8x price-to-book (P/B) ratio. Compared to the rest of the shoe store industry, this represents a 50% discount to its 1.7x average P/B valuation, and that’s where investors can get a near-free ride.

However, there is no guarantee on Wall Street. Analysts are still undecided on whether management’s plans to revamp operations will be successful. The company’s operating cash flow of $58 million, compared to a negative $118 million last year, suggests these plans are facing challenges.

CEO Mary Dillon credits these changes to Foot Locker’s ‘Lace-Up’ plan, which consists of better expense timing, seen in the accounts payable change, and improved logistics and store efficiencies.

Analysts at Evercore seem to believe in this plan, as they slapped a $32 price target on Foot Locker. The stock must rally by an additional 25% from today’s prices to prove these projections right.

Even short sellers seem to be in sync with management, as Foot Locker’s short interest collapsed by 15% over the past month, giving way for bulls to take over. While there is still a long way to go, it seems Foot Locker is stepping on the right foot.

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Costco Wholesale Can Hit New Highs; A Rebound Is Coming

Costco Wholesale (NASDAQ: COST) is highly valued because the pullback in price action provides a strategic opportunity to capitalize on it. The reason is evident in the results and in the analysts’ increased price targets. Among the details are industry-leading growth, market share gains, outperformance, and the promise of continuing value for its members and shareholders. That value includes its return on capital, dividend, and cash flow. That’s why the pullback in price action is a good thing that investors should take advantage of.

Costco Has Strong Quarter; Momentum Builds

Costco had a strong quarter and built momentum with revenue of $58.52 billion, growing 9.1% compared to last year. That is up from last year’s 2% and last quarter’s 5%, putting it in the lead compared to its leading competitor, Walmart (NYSE: WMT). The strength is driven partially by a calendar shift, but the shift is offset by fewer weeks in the quarter; the net result is that revenue outpaced consensus by 1000 basis points and will likely remain strong this year. On an adjusted basis, US comps are up 6%, Canada 7.4%, International 8.5%, and systemwide eCommerce 20.7%.

Among the signs of strength are membership fees and renewal rates. Membership fee revenue grew by 7.5% in the quarter, suggesting that revenue growth will continue at a high-single-digit pace in Q2. Renewals are running at 95.2%, which the company is happy with. The conference call was interesting because CFO Gary Millerchip says a membership fee increase is coming, but the timing is still questionable. The company is satisfied with the current rate and remains committed to delivering value to consumers.

Margin stands out in the report. The company reported a 29% increase in net income and generally accepted accounting principles (GAAP) earnings that easily cleared the high bar set by analysts. The $3.78 in GAAP earnings beat by a dime, leading the analysts to raise their price targets.

Analysts Lead Costco to a New High

Costco shares are down following the report, but the rebound should begin soon. All of the more than a dozen analyst revisions tracked by Marketbeat following the release include upward movement in the price target. The consensus estimate lags behind the stock price, but the new range is leading it higher, so it should support the market. Many revisions put Costco in the range of $850 to $880 or about 7.5% to 10% above the current action. A move to that level would be a new all-time high. The analysts’ chatter includes support for the company’s commitment to quality-for-value and praise for its market-leading performance and market share gains.

Among Costco’s opportunities is its store count growth. Its topline growth is fueled by an increasing store count and comp-store gains, and plans for store count growth are robust. The company says it can add 27.5 new stores at the mid-point of guidance per year, which will sustain a near-3% growth pace for the next few years. Along with the membership growth, results should track at the high end of the expected range and support upward movement in the price action over time.

Costco Pulls Back to Critical Support, Rebound Imminent

Costco’s price action returned to a critical support level coincident with the previous all-time high. That level should provide strong support for the market and lead to a rebound. The risk is that price action will fall below this level, near $790, and confirm it as resistance. The stock could correct another 5% to 10% in this scenario to bring the high 50X valuation back into a more reasonable zone. The stock tends to trade well above its peers, but at this level, it is more than double the value of Walmart, which is also gaining market shares and leading in retail.

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Chevron Eyes Hess, Exxon Resists: Here’s the Trade

There are plenty of ways for investors to gauge the amount of activity, or lack thereof, within an industry. One way can be seen in how the most prominent players interact with each other, mainly any rumors of mergers and acquisitions (M&A). Today, there is one such instance in the energy sector.

Chevron’s $53 Billion Takeover Bid for Hess

In the latest round of corporate actions, Chevron Co. (NYSE: CVX) sought to make big oil bigger. In a $53 billion takeover bid, Chevron is looking to buy Hess Co. (NYSE: HES) to expand its presence in the oil sector. Stock prices are at the mercy of shareholder approval whenever takeover bids are made, but not this time.

Hess shareholders have voted in favor of the takeover offer, representing a $7 billion premium to Hess’s current $46 billion market capitalization. This represents an immediate 15.2% return for those holding the stock today. However, two significant roadblocks could give investors a potential trade opportunity today.

Potential Revenue for Exxon from Guyana’s Oil Reserves

One small detail in this deal: Exxon Mobil Co. (NYSE: XOM) controls Hess’s most valuable asset in Guyana, a stake in an 11 billion-barrel field. Exxon owns 45% of this field, representing roughly 4.9 billion barrels, translating into significant revenue for the Texas oil giant.

How much? Well, today’s oil price of $80 a barrel is roughly $392 billion in revenue. Now that Goldman Sachs Group Inc. analysts project oil prices to increase as high as $100 a barrel this year, Exxon could likely make an opposing bid.

After accounting for this risk, the takeover still needs to clear the U.S. Federal Trade Commission (FTC), as having too much control over oil, especially in today’s economy, may pose a problem.

Stagflation, defined as low economic growth with high inflation, is hitting Americans hard. The 1.3% GDP growth over the past quarter and 3.4% inflation definitely fit the profile. Economists may look to oil to circumvent this phenomenon without causing too much trouble.

This is why Goldman also expects to see a manufacturing sector breakout in 2024, according to the bank’s 2024 macro outlook report. It makes sense, as heavier oil production would stimulate economic growth, and more oil supply – hence lower prices – could ease inflation.

After the Energy Select Sector SPDR Fund (NYSEARCA: XLE) underperformed the broader S&P 500, the past 3 months of price action showed a recovering rotation, as energy outperformed by nearly 4%. This is a sign of a turning economy; there’s data to back this rotation up.

Why Investors Favor Hess: Analyzing Market Premiums

Judging by ISM manufacturing PMI index trends, the oil sector is filled with upside-tail risk after three consecutive months of expansion. Hence, companies within it will likely beat earnings expectations this quarter.

That is why investors can dig deeper into the market’s language to translate the key ratios that can bring them onto a reasonable trade aligned with the perceived winner in this dogfight.

Here’s the roadmap, starting with relative valuations, mainly using the forward P/E ratio. Hess is valued at 14.3x, Exxon at 11.3x, and Chevron at the bottom with its 10.1x valuation.

Translating these numbers, Hess stands out as the top choice, which is why markets are willing to pay a premium for it. Exxon is valued over Chevron; why? Chevron could likely pay an additional premium to take Hess’ Guyana asset away from Exxon, so Exxon is valued over Chevron to reflect this potential additional bonus.

Now, price action would confirm one of these tales. Over the past quarter, Exxon Mobil stock has outperformed Hess and Chevron by as much as 5%, so bullish momentum is already trying to price this potential premium payout into Exxon stock.

So-called ‘smart money’ can be another sounding board for investors investigating this dynamic. The Zurich Insurance Group, Exxon’s second-largest shareholder, increased its take by 297% over the past quarter. At the same time, Price T Rowe Associates, Chevron’s largest shareholder, reduced its stake by 27.4%.

One final method for investors to identify the potential biggest winner in this competition: Exxon’s short interest dropped by 65.2% over the past month, while Chevron’s decreased by only 4%.

So, while Hess is the pick this season, its hidden ace up its sleeve makes Exxon’s ownership in Guyana a much better – and less risky – way to arbitrarily play out this potential merger.