Prospects for Nike in 2014

Investors in Nike have watched their stock more than "just do it" in 2013, as the stock has risen nearly 50% as I write. Moreover, retailers like Foot Locker and Dick's Sporting Goods  have recently confirmed many of the strong trends that Nike is seeing in North America. Looking into 2014, the soccer World Cup will provide an obvious upside kicker to Nike's prospects, but is all the good news already priced in?  

Nike reports a strong second quarter
The sporting giant is unusual in the consumer goods sector because its growth in recent years has been coming from developed markets (principally the US), while its emerging market performance has been disappointing.

Don't be alarmed by the sequential drop in earnings before interest and taxes, or EBIT, for North America and Western Europe. In actuality, EBIT rose 14.9% and 11.8%, respectively, for these regions in the second quarter.

Source: company presentations.

As such, the rise in Western Europe (revenue grew 18% and futures orders were up 26%) demonstrates Nike's ability to turn around performance with a strategic reset. This is precisely what the company intends to do in China as well.

North America (and to a lesser extent footwear) remains the powerhouse of Nike's operations. While investors have a right to be skeptical as to how long Nike can continue to rely on North America for growth, signs from the industry continue to indicate strength. For example, Dick's Sporting Goods reported same-store sales growth of 3.3% in its last quarter, significantly above its expectation of flat to minus 1%. Furthermore, on the conference call management outlined that "third quarter comparable store sales growth" was "led by strength in athletic footwear and apparel and team sports." 

Foot Locker also saw strength in the US, with its Foot Locker division up by mid-single digits. Interestingly, Foot Locker argued that its sales increase was "driven by average selling prices, which were up low- to mid-single digits depending on category."  Meanwhile, Foot Locker's footwear units were up, but its apparel and accessories were down as the company made a conscious decision to shift to more "premium assortments, away from more basic product." 

Nike's results nicely mirrored what Foot Locker and Dick's Sporting Goods said, in that average selling prices are going up amid ongoing strength in footwear.

However, the good news doesn't stop there because Nike is set for a strong year in 2014.

Nike's growth catalysts
The coming year promises to be a strong one for a variety of reasons:

• The World Cup in Brazil will generate strong interest in Nike's football products, especially with Nike's sponsorship of the host nation

• The consistent pattern of average selling prices rising due to a shift in product mix looks set to continue

• E-commerce revenue grew 35% in the third quarter, and Nike is in the process of launching new country sites and expanding merchandising in others

• Nike brand futures orders rose 13% (10% units and 3% average selling prices), indicating growth remains strong going into the new year

However, the most important long-term consideration is likely to be Nike's strategic reset in China. The early indications are positive, with revenue from China rising 5% in the quarter. On the other hand, anyone who thinks the battle is won should note the guidance provided on the recent conference call:

...our futures and revenue growth for China won't necessarily show sequential improvement every quarter as we move through this transition.

...we continue to expect overall FY14 revenue to be roughly in line with the prior year with single digit revenue growth in Q3 and flat to down revenue in Q4.

Where to next for Nike?
As ever, the key thing for investors is to try and take a snapshot of what Nike will look like in the future. Its 2014 fiscal year (ending in May) looks to be ending on a strong note, and positive sentiment is likely to remain for the World Cup in the summer. Furthermore, analysts expect Nike to grow revenue and earnings per share by 8.8% and 17%, respectively, for the year to May 2015.

While it all looks rosy, Foolish investors should note that this implies that the stock is trading for more than 22 times its expected earnings to 2015. A lot of good news is baked into the stock price, and any slowdown in Nike's performance in North America or a failure to execute the strategic reset in China could leave the stock exposed. After the World Cup, the market will start asking "where next?" and the focus will shift onto Nike's emerging market performance.

VF Corp's Upside Potential

In years to come, it's possible that outdoor and sporting clothing company VF Corp's (NYSE: VFC  ) last quarter could become a trivia question. Throughout the last two years, quarter after quarter, VF has raised its full-year earnings guidance. So what will the market do with the stock when it fails to do so?  

The answer is that it will mark it higher, because VF kept guidance unchanged but disclosed that it would spend an additional $40 million, or $0.25 of earnings per share, on marketing its key growth brands. The full-year EPS guidance of $10.85 was kept the same as well. While all of this is good news, the stock is up over 41% year-to-date. Is there further room for VF to run?

Good value vs. Nike and Lululemon

 Eagle-eyed readers will note that VF currently trades for nearly 20 times its 2013 guidance. This doesn't look cheap on an absolute basis, but it still trades at a discount to peers Nike (NYSE: NKE  ) and yoga gear company Lululemon Athletica (NASDAQ: LULU  ) .

VFC EV to EBITDA (TTM) data by YCharts

The key advantage that VF has over these companies is diversification. Nike is a fantastic business, but it's increasingly reliant on North America and footwear for its growth. Going forward, Nike needs to address its underperformance in China as it tries to strategically reset its business there. For example, Nike generates four times as much in earnings from North America as it does from China. Moreover, in its last results its futures orders from North America were 11%, compared to just 2% from Greater China.

As for Lululemon, the company is very focused on selling premium products in the yoga category. It doesn't offer much diversification and it's susceptible to encroaching competition. In addition, Lululemon has had to deal with some quality issues with its black yoga pants (one of its top selling items) this year. An issue that highlights how hard it is to preserve premium prices in a competitive market. It's one thing to build a lifestyle cache around a brand, but at the end of the day it is still basically selling expensive yoga pants. On a forward P/E ratio of over 27 times earnings, the stock is hardly cheap.

VF Corp's upside potential

 Frankly, VF needs some upside earnings catalysts. The good news is that it has at least five of them! 

First, the weather might be more helpful this year. VF's outdoor & action sports coalition (58.1% of 2012 total coalition profit) contains three major brands, of which The North Face--and to a lesser extent Timberland--see stronger sales when winters are colder. While Europe saw a cold winter last year, the last two years have seen mild winters in the US. Retailers have been cautious with inventories going into this holiday season. In other words, if there is a cold winter this year, then investors can look forward to some pricing upside because retailers' inventories could turn out to be too lean.

The second upside catalyst is that VF is innovating its major brands in order to broaden their appeal. For example, in an attempt to make The North Face less of a winter-focused brand, VF has launched training apparel and some new collections for the spring season. In addition, Timberland has seen an increased focus on apparel to diversify away from a reliance on footwear.

Third, VF has a margin expansion opportunity by growing its direct to consumer, or DtC, sales. DtC sales (comprising things like its own store and e-commerce sales) increased 14% in the quarter, and now make up 19% of total sales. They obviously come at a higher margin than sales via retail channels. Furthermore, the higher-margin outdoor & action sports coalition grew sales by 6.5%, compared to 4.7% for the total company.  A combination of these two factors saw gross margins expand by 90 basis points to 47.6%.  

Fourth, the increased investment of $40 million in the second half should increase revenues. Furthermore, the bulk of this investment is going into higher-margin areas. From the conference call:

"With a focus on The North Face, Vans and Timberland, 80% of the spend is in Outdoor & Action Sports. And about 70% positioned outside the U.S. and heavily D2C weighted."

And finally, VF still has significant opportunity to expand internationally. For example, Vans revenue was up a remarkable 25% in Europe, and its jeans-wear coalition (26.6% of 2012 total coalition profit) has long-term growth opportunities in China (particularly with the Lee brand) even if it's still dealing with some excess inventory issues.

Where next for VF Corp?

On its current valuation, the stock is starting to look fairly valued. However, analysts should start upgrading next year's estimates due to the increased marketing spend this year. Moreover, a cold winter and continued excellent execution with its DtC initiatives will lead to increases in growth 

 

VF may be fairly valued, but with analysts forecasting mid-teens earnings growth the stock can appreciate from here. Just keep an eye on the weather.

Nike Keeps Doing It, But For How Much Longer?

A few years ago, one of the main attractions of Western consumer goods stocks was their potential to aggressively grow sales in emerging markets. That story is still in place, but somehow Nike (NYSE: NKE  ) has managed to flip the script in recent years by generating more of its growth from mature markets.

This trend continued with the latest first-quarter results, with Nike announcing double-digit growth in North American and Western European orders. The stock hit an all-time high in response, but is it time to take profits? Moreover, can it continue to rely on mature markets for growth?

Nike flips the script

There are three key takeaways from the recent results, and each of them serves as a marker for what Nike needs to do going forward.

First, its mature markets are out-performing. A look at segmental earnings before interest and taxes (EBIT) reveals that growth this year has come from North America and Western Europe.

Source: Company Accounts

Western Europe is now generating more profits than Greater China or the emerging markets segments. Furthermore, Nike reported future orders of 11% and 12%, respectively, for North America and Western Europe. Meanwhile, Greater China and emerging markets futures grew at a less impressive 2% and 7%, respectively.

The second takeaway is the ongoing out-performance of footwear versus its other categories in regions outside of North America. The one key exception in the quarter was China (the only area where apparel notably outgrew footwear), and I'll come back to this important point later. For now, focus on how much better footwear is doing.

Source: Company Accounts

This trend is probably going to reverse somewhat because Nike will come up against some easier comparisons with apparel in the upcoming quarters.

With regards to North America, apparel grew at the same 9% rate as footwear, and management declared itself "super excited" by the performance in its women's business. This is something that might concern yoga-gear maker Lululemon Athletica  (NASDAQ: LULU  ) . After suffering quality issues with its black yoga gear, Lululemon was susceptible to losing some market share. This sort of issue is critical for Lululemon, because it's positioned as a premium seller in the marketplace.

The third takeaway was the return to growth in Western Europe. The 8% revenue growth rate (at constant currency) is pretty impressive considering it came up strong growth generated last year by football (soccer) sales inspired by the European football championships. Outside of the World Cup, the European competition is the largest in the World, and features all of the top players outside of South America.

What does it mean for Nike?

Clearly, Nike needs to improve its performance outside of North America. With this in mind, the return to form in Western Europe is a good indicator for Nike's plans in China. Nike is undertaking a similar kind of strategy reset in China to what it successfully did in Western Europe.

It would be churlish to doubt that Nike can improve its performance in China through simple 'blocking and tackling' management initiatives. For example, things like merchandising, improved product selection, and improving logistics were all discussed on the conference call. On the other hand, there are a couple of short-term concerns.

First, Nike's strong performance in North America relates to its successful sponsorship of high profile American athletes in sports like basketball or American football. It's highly unlikely that LeBron James or Kobe Bryant are going to resonate as well with Chinese consumers. Second, when questioned about the future footwear/apparel mix in China on the conference call, Nike's management replied:

So we'll have the more targeted mix of products, but the ratio of footwear and apparel -- we're not seeing a dramatic shift in that ratio. That said, we see tremendous upside in the apparel business in China for Nike to move forward and frankly around the world.

It doesn't look like Nike will specifically address why apparel is outperforming footwear in China, and this may make its strategic reset a bit harder to execute.

Where next for Nike?

Nike's stock price is at an all-time high, and even when compared to a company like outdoor-clothing company VF (NYSE: VFC  ) , Nike's valuation looks a bit rich.

 

Nike price-to-normalized-earnings less cash (trailing-12 months) data by YCharts

 

VF is arguably more attractive than Nike because it has a wider and more diverse range of brands. When market conditions are difficult for one brand, it can focus on another in order to drive growth. Whereas with Nike right now, it really is all about footwear, and its more mature geographies in particular. VF has a mix of powerful outdoor brands (such as Timberland, Vans, and The North Face) and jeanswear with which it can generate growth across the cycle.

What Nike needs to just do

If Nike is going to continue to justify this valuation it is going to have to execute better in China and emerging markets. Fortunately, the World Cup takes place in an emerging market, and Nike is well placed as the sponsor of the powerful Brazilian host team. However, the market is likely to have priced this in by now.

 

Therefore the 'swing' factor in deciding to buy the stock must be your confidence over the company's ability to turn things around in China. Furthermore, Nike will need to continue to grow at a rapid clip in its mature markets. If you think Nike can just do it, then the stock probably has further to run. For cautious investors, however, now might be a good time to take a little profit off the table.

Why VF Corp Deserves to Trade at a Premium

Outdoor clothing company VF (NYSE: VFC) is one of the most compelling growth stories in the retail sector. Its mix of brands gives it the diversity to deal with a slowdown in any one segment, and many of its brands are under-penetrated within key growth markets. Here's why it deserves to trade at a premium to the rest of the retail sector.

VF raises guidance, again

In its latest second-quarter results, the company kept up its tradition of raising guidance, hiking its full-year EPS expectations by $0.10 to $10.85.  Moreover, it declared itself on track to hit its targets for the full year. The company’s aiming for 6% revenue growth, 13% in EPS growth, and marked improvements in margins and cash flow.

While all of this is good news, it's already priced into the stock. The real question: In a weak retail environment, how is VF reporting such good numbers? And can it continue?

Diversity helps VF to outperform

The first factor that distinguishes VF is that it has a range of brands in its portfolio. This gives it significant flexibility to deal with changing retail conditions.

A good comparison would be something like Nike (NYSE: NKE).  Michael Jordan’s favorite sportswear company is doing well at the moment, but this is largely due to outperformance in North America. Moreover, much of its growth is focused on footwear.  However, the other parts of its empire are not performing particularly well, and the pressure is building up on Nike to continue to execute. Nike just doesn’t have the same kind of diversity that VF's mix of outdoor wear, sports clothing, footwear, and jeanswear generates.

You can see how well VF imanages investments in its various segments by looking at margin growth in the last quarter.

Source: company accounts.

Five out of its six segments saw margin increases, and a look at its profits for the first six months illustrates their relative importance.

Source: company accounts.

Within its Outdoor & Action Sports division lie three diverse brands. The North Face gives it exposure to the rugged outdoor hiking and mountaineering market, and equally importantly, people who want to be associated with this lifestyle. Vans generates a similar appeal to people attracted by skating, surfboarding and snowboarding, while Timberland has long been a leading outdoor wear brand. All three are placed in distinct fashion niches.



The big three brands

It isn't all plain sailing for VF. For example, Timberland has had problems due to its heavy exposure to Europe. Timberland’s European revenues were down in double-digits,but it managed to record only a 3% overall decline in revenues. On a more positive note, Timberland’s Asian revenues were up 10% and, it generated low-single-digit-growth in the Americas.

VF reacted to weak conditions in Europe for Timberland, by investing in direct-to-consumer (DtC) initiatives such as e-commerce enabled websites. These actions led to positive DtC comparables in Europe, and high-single-digit growth in the Americas.

Furthermore, its other two key brands (Vans and The North Face) have great potential to grow via international expansion. Both brands tap into the growing trend for consumers to wear outdoor activity clothing as a fashion statement. Indeed, Vans generated 15% growth in the quarter, with international sales up 20%; incredibly, Europe rose 20%. As for the The North Face, it generated 5% growth overall. The North Face’s international sales were up 20% with European sales increasing an impressive 10%.

VF has a good mix of growth opportunities from regional expansion, growing its DtC business, and favorable lifestyle trends .It can selectively invest across its brands and regions in order to counteract any weakness elsewhere.

How VF compares across its industry

Here's a brief look at how the company matches up versus its industry peers.

VFC EV / EBITDA TTM data by YCharts.

Frankly, VF doesn't merit its discount to Nike, because of the advantages (as discussed above) that VF holds over its footwear-focused rival. On the other hand, its premium to Columbia Sportswear (NASDAQ: COLM) is well-deserved.

Columbia is forecasting full-year sales to decline by up to 2.5%. Its brands do not have the kind of lifestyle appeal that VF has managed to generate with Vans or The North Face. Columbia's core clothing tends to be for activities like skiing and fishing. Arguably, these are not hobbies whose clothing has the kind of crossover appeal that VF's brands generates.  .

The bottom line

In conclusion, VF’s diversity gives it good growth prospects for the next few years. Its valuation of over 18 times forward EPS estimates may look expensive, but the company has low-teens-growth forecasted for the next couple of years. In addition, it is expecting to generate around $1.4 billion in cash flow for 2013.

Arguably, the stock is fairly valued right now, but if it hits its low-teens EPS growth targets, then it’s reasonable to expect the stock to return at least low-teens returns for investors over the next few years.

The Pressure is Bulding on Nike

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.

NKE Price to Earnings Less Cash TTM data by YCharts

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.