This Sports Stock is Set To Jump Higher

Gaurav is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Sporting goods giant Nike (NYSE: NKE) recently reported strong Q2 results with earnings from continuing operations of $1.14 per share, compared to last year’s $1.03 and consensus estimates of $1.00. It is encouraging to see that the company has followed its 15 cent EPS beat last quarter with an equally impressive quarter. This is also the fourth consecutive quarter in which the company has managed to increase its revenues. The market has responded favorably to the Q2 results and shares have gained more than 5% over the last week. The consensus estimates for FY12 and FY13 have both seen some upward revisions over the last few months, and I look forward to more upward revisions in the coming months.

The athletic industry currently faces many changing dynamics across its value chain. As a result of consolidation, fewer manufacturers are selling products to fewer retailers. Competition has intensified and a lot of the control footwear manufacturers once had is now in the hands of the retailers. I am optimistic about Nike due to its flexibility to operate in this changing environment. I believe Nike is creating a platform in which it has the ability to cater to many different consumers through its wide product and brand offering, and I expect the business will continue to evolve and capture new growth opportunities in apparel and footwear while continuing to grow the core Nike brand. I think the company's strategy is unique when compared to its competitors in the athletic arena and creates a competitive advantage for the company.

Let’s take a look at the valuation metrics of Nike and its domestic as well as global competitors Adidas, PVH (NYSE: PVH) and Deckers Outdoor (NASDAQ: DECK). The following tables summarize the forward PE and PEG ratio of these companies.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Nike</p> </td> <td> <p>Adidas</p> </td> <td> <p>PVH</p> </td> <td> <p>Deckers</p> </td> </tr> <tr> <td> <p>Forward PE</p> </td> <td> <p>8.74</p> </td> <td> <p>14.96</p> </td> <td> <p>14.55</p> </td> <td> <p>10.07</p> </td> </tr> <tr> <td> <p>PEG Ratio</p> </td> <td> <p>1.22</p> </td> <td> <p>3.12      </p> </td> <td> <p>1.38</p> </td> <td> <p>1.37      </p> </td> </tr> </tbody> </table>

From the above table, we can see that Nike is trading at a heavy discount to its peers. However, I don’t think such a discounted valuation is justified. Although Adidas has a far lower expected growth rate over the next 5 years (5.70% as compared to Nike’s 8%), it is still trading at a 71% premium to Nike. I admit that both Deckers and PVH are going strong and have good long term growth prospects, but the valuation gap appears to be highly exaggerated. If we look at the growth adjusted multiple (PEG ratio) of these companies, we can see that Nike has the lowest. Thus, I see good upside potential in the stock.

The athletic product cycle in the U.S. remains healthy, and Nike is tapping into this opportunity quite nicely. The company is building solid sales momentum in its most mature market (North America), with future orders growth of 14%. Nike's brand is equally famous among general sports consumers as it is among serious athletes, and I believe that despite large market share in the US, Nike can continue to outpace industry sales. In addition, I think a similar trend will follow in the developing countries as well, and Nike should benefit from the increasing consumer spending on athletic apparel and footwear globally.

Speaking of the steep sales decline in sales in China, I am not overly worried about it as it is a part of the company’s strategy to stabilize the business in the region. Nike is transitioning its strategy in the region this year, in terms of product design, brand positioning, and distribution, and is expected to ultimately return to robust growth. The company’s range of basketball products are generating a lot of heat in the European markets, as the sales of Nike basketball products grew double-digits in Central, Eastern, and Western Europe. Thus, the company seems to be well positioned with a strong hold on domestic markets, good trends in Europe, and an expected recovery in the Chinese market.

In my view, Nike’s execution has actually improved in recent quarters. When all said and done, it is important to recognize that China's moderating trend is being offset by robust growth in North America and emerging markets. Also, Nike's cash allows the company the flexibility to pursue a variety of strategies for creating shareholder value. I think there is potential for Nike to create further opportunities for growth through a greater investment in its women's business, opening more Nike or Nike Goddess retail stores, creating new and innovative products or brands, increasing its dividend payout and share repurchase programs. Thus, I recommend buying this stock.

gauravguru has no positions in the stocks mentioned above. The Motley Fool owns shares of Nike. Motley Fool newsletter services recommend Nike. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus