Buying Opportunity in this Powerful Brand
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Shares of Nike (NYSE: NKE) fell around 9.4% last Friday after the company's results disappointed analysts and investors. Certain difficulties in inventory management could last for a few quarters, and Nike is also vulnerable to economic hurdles, but this is a high quality business with very strong competitive advantages and solid fundamentals. Long term investors should consider the possibility to capitalize on current weakness and buy shares of this outstanding company at attractive valuation levels.
Earnings per share were materially below expectations at $1.17 versus $1.37 estimated by Wall Street analysts. But revenues, on the other hand, barely missed expectations and were still quite healthy with a 12% annual growth rate. Higher inventory costs reduced gross profit margins, and marketing expenses – Nike gives them the much appropriate name of “demand creation expense” – were quite high due to the coming Olympic Games. Nike also paid a higher effective tax rate in the quarter at 26.1% versus 23.2% in the same quarter of the previous year.
Inventories have been an issue for several quarters now, and it looks like they are finally starting to take a toll on the company's gross margins. Management needs to focus on this problem and tackle it for good, but it will probably take some work and considerable time. This is nothing too dramatic or permanent though, Nike and other companies in the industry have faced these kinds of complications in the past, and there is no reason to believe the current situation cannot be worked out.
Regarding marketing expenses, it wouldn't be wise to criticize the company on that front. The expression“demand creation expense” seems more adequate in this case, as Nike has historically produced many of the most memorable marketing campaigns in its business, and this has positioned the company as an undisputed leader in athletic footwear and apparel on a global scale. This kind of expense can weight on a company's quarterly earnings, but if done adequately they can produce growing sales and cash flows for year to come.
Nike is well positioned for growth in Asia, Latin America and emerging markets in general, the brand is very popular in those geographies and rising income levels bode really well for the company's premium image. Sales in emerging markets grew by a 16% last quarter, but the figure was a much higher 23% if we exclude exchange rate fluctuations.
China in particular is a very promising market for Nike, where the company is enjoying growing demand and exciting long term prospects. Apparel sales in China were below estimates in the last quarter, growing only by 7% annually, but footwear was very strong, showing a 25% annual increase. Overall, sales of Nike in China grew by 18% last quarter, so investors are probably exaggerating about the negative effects the Chinese economic slowdown could have on the company's performance.
The company has developed a position of strength when it comes to dealing with its retail customers, Nike products represent around a 50% of total sales for Foot Locker and Finish Line combined, meaning that these two companies are sensibly dependent on Nike. While companies like Foot Locker and Finish Line compete among each other for growth opportunities, Nike seems to be in a comfortable position capitalizing on the expansion of both businesses.
The company has established a solid dividend growth policy and also distributes cash to shareholders via stock buybacks. There is no reason for concern on the financial front, Nike has more cash and short term investments than financial debt, and the company has managed to deliver positive earnings and cash flows during recessionary periods like the 2008-2009 financial crisis. The business is sensible to the economic cycle, but Nike has demonstrated it can sale through the most turbulent waters without suffering too much damage.
In terms of valuation Nike is much cheaper than other sports clothing companies like Under Armour (NYSE: UA) and Lululemon (NASDAQ: LULU). These two companies are smaller and have achieved higher growth rates in the past, so they can probably grow faster in the future. But Under Armour and Lululemon lack the global recognition and diversification that Nike provides, so they can be considered riskier investments with lower fundamental quality.
Nike is an outstanding business which owns one of the most valuable brands in the world and a very strong financial position. If history is any guide about the future, current weakness should be considered a buying opportunity from a long term point of view.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Lululemon Athletica and Under Armour. Motley Fool newsletter services recommend Lululemon Athletica, Nike, and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.