What You Must Know About Nike

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

In the last 3 months, Nike's (NYSE: NKE) stock price has surged 12.25%. If you are excited by that, you would probably jump at this one. Nike's stock price has appreciated 73.8% in the last 5 years. And that includes the period of the Great Recession (2007-2010) as well. Mark Parker's efforts to improve the company are showing through stock price appreciation.

<img src="http://static.cdn-seekingalpha.com/uploads/2013/3/1007064_13643086864301_0_thumb.jpg" />

But here's a fact. Historical prices can never be used to identify future growth patterns. We are more interested to know how Nike would probably do in the next couple of years.

For that, we have to check a couple of factors.

Revenue growth

If you look at the chart below, QoQ revenue growth seems to be pretty strong for Nike. Strong revenue growth is always important for any company, as higher revenue leads to improved profitability.

<img src="http://static.cdn-seekingalpha.com/uploads/2013/3/1007064_13643086864301_1_thumb.jpg" />

Having said that, let us take a look at another chart that might interest you. We are talking strictly about YoY quarterly revenue growth percentages here.

What I am going to say is a bit theoretical, but the pattern concerns me. 2008 was still a strong year with double-digit growth when the Great Recession already started by mid-2007. Needless to say, the double-digit growth toned down to single digits, and then went negative in the next couple of years.

Similarly, in 2012, we saw double-digit YoY quarterly revenue growth again. And it again got driven down to single digit in 2013. Considering the lingering Eurozone crisis and the slowing global economy, are we looking forward to further setback in revenue growth?

<img src="http://static.cdn-seekingalpha.com/uploads/2013/3/1007064_13643086864301_2.jpg" />

From the recent data by Nike, future orders are still steady at a moderate rate though. Taking a look at the image below, North America should drive some revenue growth while the Chinese market shows moderate demand in the coming fourth quarter. However, futures and advance orders are just a small part of Nike's revenue, and just help in determining a trend. Futures/advance orders never match actual revenues, remember.

<img src="http://static.cdn-seekingalpha.com/uploads/2013/3/1007064_13643086864301_3_thumb.jpg" />

The Chinese market

While the company seems to be going strong in Canada, there has been a slack in the European and Chinese markets. Let us look at the graph below.

<img src="http://static.cdn-seekingalpha.com/uploads/2013/3/1007064_13643086864301_4_thumb.jpg" />

As Donald Blair, CFO of Nike, said in the latest earnings call transcript:

"Q3 revenue for Greater China declined 10% on a constant currency basis and fell 9% on a reported basis. EBIT decreased 20%. We are continuing to take decisive actions to reestablish a pull market in China and our Q3 results reflect the impact of those actions, as both revenue and gross margin were below the prior year.

As Charlie indicated, we are seeing some early signs that our strategies are taking hold. While we are making progress, we are not done. We will continue to work with our retailers to right-size inventory, accelerate sell-through and improve retail productivity. Consistent with our accounting policies, we have made provisions for expected returns and discounts in our Q3 results and we will be tightening the amount of product we ship into the market over the next few quarters. As a result, we expect Q4 reported revenues for Greater China will be lower than the future's orders would indicate."

I would like to note here, almost the whole of the Asian region's demand has been affected.

Morgan Stanley (NYSE: MS) analysts said the company management has demonstrated strong execution, but results would take longer than expected. They are hinting towards China, where seven quarters of inventory hangover after the Beijing Olympics, coupled with continued labor cost inflation, are likely to weigh on the company.

Balance sheet analysis

With a strong asset utilization score of 1.639, the company seems to be balancing its capital funding and usage quite efficiently. Cash and equivalents increased 27% to $2.6 billion in Q3 of FY13. Short-term investments surged 26% to $1.5 billion in the most recent quarter. Along with that, long-term debt rose by only 2% while shareholders' equity rose by 5%. The company's inventory rose 4% to $3.3 billion, which indicates growing demand from the consumers (and thus, higher revenue). While capital expenditures rose to $143 million last quarter, it is properly managed with rising income and declining debt.

<img src="http://static.cdn-seekingalpha.com/uploads/2013/3/1007064_13643086864301_5_thumb.jpg" />

Income Sheet Analysis

While the rising selling, general and administrative expenses did get my attention at first, it is properly compensated with much-higher increments in gross, operating and net margins. Let us take a look at the image below.

<img src="http://static.cdn-seekingalpha.com/uploads/2013/3/1007064_13643086864301_6_thumb.jpg" />

Looking at the table below, Nike's margins look impressive, even in this transition phase to owned distribution in UK and China. The only other company that can boast better margins than Nike is Crocs, Inc. (NASDAQ: CROX). Then again, with Nike's market cap being 53 times that of Crocs, I would not consider Crocs a threat yet. Apart from that, the rest of the companies, such as Deckers Outdoor Corp (NASDAQ: DECK) and Dick's Sporting Goods (NYSE: DKS) are doing well but not as good as Nike again. Some of the competitors such as K Swiss (NASDAQ: KSWS) and Skechers USA (NYSE: SKX) are running in the negative even. In short, compared to its immediate peers, Nike stands out.

<table> <tbody> <tr> <td> <p><strong>Companies</strong></p> </td> <td> <p><strong>Gross Margin %</strong></p> </td> <td> <p><strong>Operating Margin %</strong></p> </td> <td> <p><strong>Net Margin %</strong></p> </td> </tr> <tr> <td> <p><em>Nike, Inc.</em></p> </td> <td> <p>43.4</p> </td> <td> <p>12.36</p> </td> <td> <p>9.21</p> </td> </tr> <tr> <td> <p><em>Crocs, Inc.</em></p> </td> <td> <p>54.12</p> </td> <td> <p>13.01</p> </td> <td> <p>11.69</p> </td> </tr> <tr> <td> <p><em>Deckers Outdoor Corp</em></p> </td> <td> <p>44.69</p> </td> <td> <p>13.22</p> </td> <td> <p>9.12</p> </td> </tr> <tr> <td> <p><em>K Swiss Inc.</em></p> </td> <td> <p>34.61</p> </td> <td> <p>(13.81)</p> </td> <td> <p>(15.61)</p> </td> </tr> <tr> <td> <p><em>Sketchers USA Inc.</em></p> </td> <td> <p>38.84</p> </td> <td> <p>(8.33)</p> </td> <td> <p>(4.21)</p> </td> </tr> <tr> <td> <p><em>Dick's Sporting Goods</em></p> </td> <td> <p>30.6</p> </td> <td> <p>8.29</p> </td> <td> <p>5.06</p> </td> </tr> </tbody> </table>

Valuation Analysis

Even though EPS (TTM) increased, earnings yield fell. This means that even when the company is earning more, the price is just too much to justify that. It must be remembered that Nike's PE ratio is already 23.46, much higher than 10.42 of Crocs and 13.82 of Deckers Outdoor Corp. In fact, PE ratio rose by 26.95%, whereas theoretically, the percentage should be zero. That's alarming, but it is still hard to say in which direction the price would go in the short term.

<img src="http://static.cdn-seekingalpha.com/uploads/2013/3/1007064_13643086864301_7_thumb.jpg" />

Conclusion

Although there is much hullabaloo about Nike these days, I would say Nike is a moderate buy at the moment. I love Nike's products myself and would like to see it succeed as a company in the future. Having said that, it presently seems to be at a stage where it needs to prove its worth in the market. The almost-average margins, the transition phase and the global economy crisis - all these make me so pessimistic that I cannot put my last dollar on this company yet. A moderate buy is not good enough for me.


Ron Chatterjee has no position in any stocks mentioned. The Motley Fool recommends Nike. The Motley Fool owns shares of Crocs, Nike, and Skechers. 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