Running with the Athletic Footwear Giant

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

Nike (NYSE: NKE) is set to report its Q2 fiscal year (FY) 2013 earnings on December 20. In Q1 FY 2013, Nike reported revenue of $6.7 billion, which was up 10% year over year (yoy). Excluding changes in currency, revenue was up an impressive 15% yoy. However, Nike’s bottom line did not rise with revenue. In the quarter, net income decreased 12% and diluted EPS decreased 10% yoy. The company continued its trend from the fourth quarter. In Q4 FY 2012, revenue grew by 12% and under constant currency revenue increased 14% yoy. However, net income decreased 8% and diluted EPS decreased 6% yoy.

Margin, SG&A, Taxes

Nike’s decline in its bottom line is due to lower gross margin, higher selling and administrative expenses (SG&A), and higher effective tax rate. Nike’s gross margin is complex, but the company attributes the decline in margin to higher material and labor costs; new products, which have lower margins; and the switch to direct distribution for the Converse brand in China. Looking at SG&A, Nike continues to invest in innovation. In addition, the company had higher expenses due to marketing for the 2012 Olympics. The company’s demand creation expenses grew 29% yoy. Lastly, effective tax rate was 27.5% versus 24.3% in the previous year. The rise in effective tax rate was due to a rise in percentage of revenue from higher tax regions. Revenue in North America increased a massive 23% yoy.

In the company’s Q1 FY 2013 earnings call, Nike’s CFO Don Blair stated, “For Gross Margin, we expect the year-over-year decline in Q2 to be generally in line with Q1 actual results, as improving input costs and the benefits of higher prices are more than offset by weaker foreign exchange rates. For the second half of FY13, we continue to expect sequential gross margin improvement quarter-on-quarter, with margins essentially flat for the full year.” Also, for Q2 and the full fiscal year, Nike forecasts SG&A to grow at the same rate as or a slightly higher rate than revenue. In addition, Nike forecasts a FY 2013 effective tax rate of about 26.5% and revenue growth (under constant currency) in the range of high single to low double digits. The effective tax rate in FY 2012 was 25.5%. If everything goes as forecast, net income looks like it should grow for the fiscal year. In the coming Q2 FY 2013 earnings release, investors should look for guidance on gross margin and effective tax rate.

ROA = Efficiency

Despite the year over year declines in net income for the past two quarters, Nike is still efficient. For the trailing twelve months (TTM), Nike has a return on assets (ROA) of 14.34%. ROA is a good measure of efficiency because it measures the amount of money the company is generating with its assets. The following chart compares Nike with competitors Under Armour (NYSE: UA), Skechers USA (NYSE: SKX), Deckers Outdoor (NASDAQ: DECK), and Wolverine World Wide (NYSE: WWW).

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NKE Return on Assets data by YCharts

As shown, in the past five years, Nike has delivered consistent ROA and is currently on top. Deckers Outdoor’s ROA has historically been above Nike, but the company is currently facing high sheepskin costs. Looking at growth, Nike has a five year compound annual growth rate (CAGR) of 8.13%. In comparison, Under Armour, Skechers, Deckers, and Wolverine have five year CAGRs of 27.88%, 5.91%, 35.24%, and 4.29%, respectively. Nike should benefit from the overall growth in the global athletic footwear industry. Market research firm Lucintel projects a CAGR of 5% for the industry from 2012 to 2017.

Bottom Line: Long-term Value

Looking at valuation, Nike currently has a PE ratio of 21.4. In addition, the company has a tangible book value per share of $20.66. Nike has a good balance sheet. The company has about $2.2 billion in cash and equivalents and only $364 million in total debt. In addition, Nike recently agreed to sell Cole Haan to Apax and Umbro to Iconix. By selling the two brands, Nike can focus on its core businesses. Overall, Nike is a great long term investment. However, a PE of 21.4 is not cheap and Nike’s net income declined the last two quarters from the previous year. To minimize risk, investors might want to wait for a cheaper price. Regardless, Nike is a strong company.

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

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