This blog is devoted to helping investors make informed decisions. It will be regularly updated and provide opinions on earnings results. It is not intended to give investment advice and should not be taken as such. Consult your investment advisor.
Nike (NYSE: NKE)
is one of those companies whose results will interest the whole of the
retail industry as well as its own shareholders. And given its recent
results there are many things to consider. It’s a story of strong
execution in North America and with footwear in particular. However, its
European markets remain weak and China is displaying the kind of
softness that others are seeing.
In summary, Nike's prospects are reliant upon continued success
within its North American operations and the belief that it will turn
around its performance in China. If either of these things fail then the
stock's evaluation will start to look a little stretched. The stock may
have some good near-term upside drivers, but I think it also has
downside risk and this article will explain why.
Nike triumphs in North America
In order to illustrate the importance of the performance of its
North American operations I’ve broken out its quarterly earnings before
interest and taxes (EBIT) below.
Indeed over the course of this graph, its North American segment has
increased its contribution to overall segmental EBIT from 44.3% to
48.6%. Meanwhile China (traditionally its highest margin market) has
disappointed and the only other regions to be at a high watermark are
emerging markets and the CEE.
Moreover in terms of categories, footwear contributes two
thirds of its North American revenues and the growth outside North
America is largely coming from footwear.
Clearly the strong performance over the last years is thanks to North
America and footwear globally. Part of this is – no doubt- due to the
success of sponsorship deals with established stars in sports like
basketball and running. Another favorable aspect is the trend towards
casual footwear.
The last point is an industry trend that shouldn’t be underestimated. For example a company like V.F. Corp(NYSE: VFC)
has some strong outdoor activity brands such as The North Face, Vans
and Timberland. All three of these brands contain a strong superficial
appeal to consumers but, not necessarily from those that do actually
undertake mountaineering, hiking or skate boarding! People will buy the
products just to be associated with these sports (and the lifestyle)
even if they don't do them so -almost bizarrely- marketing efforts must
focus on promoting these activities.
Growth opportunities
Aside from ongoing execution in North America, there are three main near-term growth opportunities.
Firstly, not only is Nike getting its marketing right but its
multi-channel efforts are bearing fruit too. Direct to consumer (DtC)
sales in North America increased 20% to $2.5 billion for the year while
e-commerce sales up were up 30%. Again this sort of growth is in line
with industry trends. For example, V.F. Corp is also investing
in its DtC facilities in order to increase its share of revenues from
21% in 2012 to 23% in 2013. Overall Nike’s DtC revenues grew 24% (at
constant currency) and now make up nearly 19% of total revenues. In a
sluggish global economy I would expect more emphasis to be placed on
this secular trend.
The second near-term catalyst will come from next year’s soccer World
Cup in Brazil. Soccer gear only makes up 9.2% of total revenues but it
is a strong category in emerging markets (which grew 19% last year) and a
World Cup in Brazil (Nike sponsors the Brazilian team) will obviously
have added allure. Nike should be able to generate revenue growth in
strategically important markets.
The third catalyst could be a pick-up in performance in China. As
ever investors will consider whether this is a macro or company-specific
issue. On the macro side, even though Nike said that conditions hadn’t
changed over the last quarter I note that V.F.Corp and others have been
performing relatively weaker in China. Elsewhere there are signs that
China is experiencing less rapid growth in its business sector then many may have hoped. Is this feeding through into the consumer? On
the company specific side, Nike has been undertaking concerted efforts
to increase sales efficiency in China for a few quarters now.
The company is taking a long-term view over China, but for the very
near term it expects Chinese revenues in the first half of its 2014 to
be lower than last year and its future orders are flat on last year too.
Any weakening in the Chinese economy will hurt Nike as the country
currently provides nearly 22% of segment EBIT.
Where next for Nike?
Nike’s future orders indicate growth of 12% for North America and
emerging markets, respectively, while Western Europe and China future
growth is at 0%.This pretty much defines where the near-term growth will
come from.
Analysts have low teens earnings growth penciled in for the next two
years. I would argue that the stock is close to 'fair value' as it is
currently generating 4.7% of its enterprise value in free cash flow.This
suggests that the best its stock price can do is to return its earnings
growth over the next few years. There is nothing wrong with this
because low teens stock returns are fine for most people. On the other
hand these earnings prospects will rely on the issues discussed above.
An increasing reliance on North America and footwear could place
pressure on its performance whereas a stock like V.F. Corp has a wider
and more diverse range of brands.
By way of comparison V.F. Corp registered mid-single digit declines
with Timberland in Europe (its strongest market) but was able to offset
this by generating an incredible 30% increase in Vans sales in the
region. Moreover it increased its global DtC revenues for The North Face
and Vans by 25% and 20% respectively. Clearly the company has more
opportunity to shift emphasis onto brands/geographies that are working
and it also trades on an evaluation discount to Nike. V.F.Corp trades on
18x this years earnings while Nike trades at nearly 21 times earnings
to next May.
In addition from a historical perspective Nike isn’t particularly cheap.
In conclusion, the stock isn’t really a value prospect but more
of a growth at reasonable price proposition. Ultimately an investment
decision will be based on how you view its ongoing growth prospects. So
with a degree of uncertainty over China at the moment I think cautious
investors would do well to wait for confirmation of better conditions
there before buying in here. Its evaluation leaves little room for
error.
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