Industry leader Foot Locker has a more appealing valuation

Hot on the heels of Black Friday’s robust sales reports, footwear retailers Foot Locker (NYSE:FL) and Finish Line (NASDAQ:FINL) were greeted Monday morning with analyst upgrades. And their shares are up a whopping 10% and 6%, respectively, in midday trade after? UBS upgraded Foot Locker to buy, while Zacks upgraded Finish Line to outperform.

These moves are exciting for investors who bought the shares last week, but beware because the footwear retailing industry, while big, is shrinking. According to IBISWorld, 2011 revenues will total $20 billion, but that would be 5% below its 2010 level. Underlying that decline is a slow economy. And industry profitability is capped by the sheer variety of rivals — including mass merchandisers, discount stores and nontraditional retailers that are selling products that are mostly commodities.

IBISWorld estimates that Foot Locker is the industry leader with 18.7% market share, while Finish Line is much smaller: It has 660 stores — a mere 19% of Foot Locker��s 3,426.

Foot Locker’s recent financial performance has been good. It earned 43 cents a share — four cents above expectations — when it reported third-quarter 2011 results on Nov. 17. Thanks to sales of running shoes, Foot Locker was able to report its seventh consecutive quarter of results that? beat. Sales of $1.39 billion grew 9% — a big improvement in a declining industry.

But Finish Line also reported better-than-expected earnings on even faster sales growth.? Its second-quarter 2012 earnings of 39 cents per share were a penny ahead of the Zacks consensus estimate. And Finish Line��s sales were up 10.1% to $331.5 million due to high back-to-school demand, bigger transactions and online sales that climbed 61%.

So here’s what the investment choice between Foot Locker and Finish Line boils down to:

• Foot Locker: growing strongly! ,?narrow margins; cheap stock. Foot Locker sales have risen 4% in the past 12 months to $5.5 million, while its net income spiked 260% to $254 million — yielding a?low net margin of 4.6%. Its price-earnings to growth ratio (where a PEG of 1.0 is considered fairly priced) of 0.97 is cheap on a P/E of?13.1 and expected earnings growth of 13.5% to $2 in fiscal year 2013.
• Finish Line: growing, decent margins;?expensive stock. Finish Line sales have increased 4.8% in the past 12 months to $1.3 billion, while net income has increased 35.5% to $74 million — yielding a slightly wider 5.9% net profit margin. Its PEG of 1.62?is expensive on a P/E of 14.7 and expected earnings growth of 9.1% to $1.71 in fiscal 2013.

Foot Locker wins this investment foot race, thanks to a more reasonable valuation. But given its wider margins, I would consider Finish Line if it can speed up its earnings growth.

Peter Cohan has no financial interest in the securities mentioned.