Nike: Down(graded) But Not Out
Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Analyst firm McAdams Wright Ragen downgraded Nike (NYSE: NKE) from Buy to Hold on December 5th, and since then the stock hasn’t done much except chop sideways around the $98 level. For the 9 months that that McAdams Wright Ragen had a buy rating on the stock it appreciated 24%. Does the removal of their rating signal the end of the runup?
The 10Q Nike just posted is a little tepid. Even though revenues went up 18% year on year, net income only increased 3% and earnings per share went up 6%. The problem is that selling and administrative expenses went up 13% year on year as well, and is stealing cash before it can make its way to the bottom line.
The selling and administrative expenses isn’t all dead losses. Marketing costs and brand building are built in to this cost component. Fun fact, these marketing costs are labeled on Nike’s financial statements as "Demand Creation Expense," and they are the only ones I have seen use this term.
Marketing, brand building and strong intellectual property are important to Nike. The company owns twice as many patents as its five largest competitors do put together. This is a major moat between Nike and the likes of Adidas (NASDAQOTH: ADDYY) , New Balance, and Puma.
Besides employing an orcish-sized horde of patent lawyers, Nike goes out of their way to get the best professional athletes and Olympians to endorse their products. All of this builds brand value, but is an expense rolled into the selling and administrative line and not rolled into shareholders' pockets this quarter.
Nike still has room for growth in China, and earnings has done nothing but climb. Perhaps McAdams Wright Ragen didn’t like where the P/E for Nike is right now relative to its historic range. After all, they have stated a value investment focus to their ratings approach. I however, would like to point out that spikes in Nike's P/E value do not seem to adversely effect the stock's capital appreciation rate.
Focusing on relative valuation may be causing McAdams Wright Ragen to ignore the growth prospects of Nike, which remains a best in class company, with a track record of earnings growth, and a very real competitive moat in intellectual property and brand value.
The author does not own any financial interest in the company mentioned. Forward looking statements in the article are the author's opinion, and no guarantee can be provided of their future validity.