Nike, Inc. ($NKE)
Nike, Inc. ($NKE)
"One of the world's greatest brands in a 50% drawdown!"
This write up was done in collaboration w/ Mark Hogan @
.100% of the research was done by Mark Hogan, I just added couple of final touches.
If you would like to learn more about Mark, check out his Twitter / X & his Substack.
Nike NKE 0.00%↑ , one of the most well-known brands in the world, makes athletic footwear and apparel. It is nearly the worst performer on my watchlist with a 5YR return (CAGR) for its stock of only 3%.
Quality (4/5)
Nike’s 10-year revenue CAGR is a sustainable 7%. The only revenue declines on a trailing-twelve month basis (TTM) were in 2009-2010 and 2020-2021, as seen in the Koyfin historical chart below.
Nike is on 23 consecutive years of dividend increases, however, the yield is relatively low at 1.5% today. Financial leverage is not excessive at 2.6X, as measured as total assets over total equity. Nike had $10.6B in cash & short-term investments on its balance sheet, as of Q3 FY24, and $12.1B in debt (including operating leases).
I take one point off in the Quality category due to the low revenue exposure in the U.S. (~45% of sales are in North America) and 14% of revenue going to China. I prefer companies with higher U.S. sales as a percentage of total sales.
Visibility (2/5)
Visibility at Nike has been very low since the pandemic. Take a look at the EPS revision trends for FY22-FY24 below.
Analysts were expecting FY23 EPS to be around $5 and FY24 above $5.50, however, those estimates came down dramatically to ~$3 in FY23 and ~$3.50 for FY24. Management provides a variety of excuses for this poor performance on its earnings calls, mainly China uncertainty, supply chain issues, inventory adjustments, and its channel shift to digital. I would not be surprised if newer competition is causing issues as well.
Is Nike simple, boring, and understandable? Well, it is a complex global business, it has fashion trends that are hard to predict, it has questionable business practices and political statements, and management does not make it any easier with its long-term targets that it puts out. On top of that, management is now restructuring and including non-GAAP metrics to adjust its EPS. These factors make the business difficult to understand and troublesome to forecast in the near-term.
On the plus side, there is a recurring element to Nike’s model due to its Nike Plus membership program that has around 150-160M active members. Management notes that members are more likely to repeatedly buy Nike footwear. In addition, shoes typically wear out in a year or two, requiring repeat purchases. Also, there are many shoe collectors that buy multiple pairs every year, regardless if they truly need new shoes or not.
Management (5/5)
Nike is led by CEO John Donahoe (since January 2020), who was previously at ServiceNow, a software company. As Nike was pushing into its digital business, it made some sense to bring in a technology CEO to run the company. Matt Friend has been the CFO since April 2020 and with Nike since 2009. The Chairman role is independent from the CEO, which is preferable, and is former CEO Mark Parker, who has been with Nike since 1979.
Over the last ten years, I calculate cumulative free cash flow (FCF) of $36B and share buybacks of $33B.
In addition, I calculate Nike’s median return on invested capital (ROIC) over the last decade to be 40%, well-above its cost of capital.
Nike limits its use of dilutive options with stock-based compensation only 1.5% of total revenue. In the chart above, one can see the share count is down 13% over the last ten years.
Insiders own less than 1% of shares out, according to the latest proxy filing. However, Swoosh LLC owns 77% of Class A stock and 16% of Class B. According to the press release, Phil Knight (co-founder of Nike) used Swoosh LLC to transfer his ownership of Nike.
Demand Creation (5/5)
The name of this section actually comes from the expense item on Nike’s income statement called “Demand Creation Expense”. I was asked, ‘Mark, is demand creation not just marketing expense?’ That is a good question and one I asked myself before.
I believe it is more of a philosophical debate, but essentially, Nike can truly create demand for its products, in my opinion. For contrast, Exxon Mobil can market its gasoline and say it has special detergents that clean your engine, but they cannot charge $20/gallon for it when the 76 gas station down the street has basically the same gas for $5/gallon. Drivers typically go to the nearest or cheapest gas station. Its marketing would simply be marketing, but not ‘demand creation’.
With Nike shoes, though, Nike can sign endorsement deals with top athletes and create demand for the shoes that the athletes wear. Nike can create a lifestyle of exercise and healthy choices that people aspire to match. Spending $170 on a pair of Nike shoes when $50 shoes exist from other brands starts to make sense for some people. It could be, ‘I want to be the best player on the court, so I need Nikes, and I cannot be in the cheap shoes’, or ‘I want to be seen as someone who is healthy and exercises, so I need Nikes’. So, I categorize this partly as marketing, but ‘demand creation’ as a whole.
Nike definitely has effective marketing and brand recognition as evidenced by Interbrand ranking it the 9th best brand in the world. With $50B in annual sales and 60 years of footwear manufacturing experience, Nike has size and scale advantages over peers.
Switching costs may be a factor for the highest level of athletes due to custom shoes or endorsement deals. Otherwise, it is fairly inexpensive to switch to other brands for shoes or apparel. There is a good example of the switching costs later in the Risks section when we look at Nike’s German football win.
Valuation & Pricing (3/5)
Attached below is my latest discounted cash flow (DCF) analysis of Nike:
I set revenue to grow 7%, in-line with the last decade. This is above recent growth of 1% and below management’s target of HSD-to-LDD growth. In the latest earnings call, Nike said sales would decline LSD in the first half of FY25 before accelerating in the back half, leading to a LSD increase in sales for the full-year.
“Jay, the way I think about fiscal '25 is that we are taking our product portfolio through a period of transition. We talked about this last quarter.” (NKE: 2024 Earnings call Q3 2024 Transcript, 2024-3-21)
“And because we've been missing some product newness at scale in our portfolio over the last several seasons, these actions are resulting in a decline of low single digits is how we're thinking about the first half of the year. But we believe we will inflect in the second half and grow next year on the top line. And when we step back and think about the importance of newness and innovation, and not just to drive the top line but to create consumer impact at scale, that's the foundation for us driving long-term growth.” (NKE: 2024 Earnings call Q3 2024 Transcript, 2024-3-21)
EBIT margin expands to 16% from 11.6% today due to a higher mix of digital sales. My cost of capital is estimated to be about 8%. I end up with an estimated value per share of $83 compared to the current stock price of $95.
For pricing, I looked at Nike relative to itself, the market, and its peers. In the Koyfin chart at the beginning of this post, we can see Nike’s multiple has come down greatly since the pandemic. On a NTM basis, Nike trades at 26X today compared to a 20-year mean of 24X and +1SD of 32X.
Why did Nike get such a high multiple during the pandemic and why is it lower now? I think we saw a glimpse (one that did not last long) into the future of what higher digital sales mix could do to Nike’s fundamentals. EBIT margin hit a high of 16% compared to a mean of 13%, and management was targeting high-teens EBIT and HSD-LDD growth. When you put that into the DCF model, along with the ultra-low interest rates at the time, it resulted in a stock price around $150/share.
That scenario has not played out. Instead, EBIT margin is at 12% today and growth slowed to 1%.
Nike trades close to a market P/E (using SPY) and is in the 60th percentile relative to itself for P/E NTM. It is nice to see a stock that is not trading at its 99th percentile for pricing.
Compared to peers, NKE is less expensive than Lululemon LULU 0.00%↑ and Deckers DECK 0.00%↑, and in-line with other great consumer companies like Walmart, TJX, P&G, Disney, and McDonald’s.
With EPS approaching $4.10, a 25X multiple results in a price of $103/share. Estimates have been coming down for many years, so this could be too optimistic. Combining my valuation and pricing, I get a buy-below price of $93, or 2% below today’s price of $95. I own Nike stock already, but it's come down 45% while the rest of my stocks increased in price greatly, so it is less than 2% of my portfolio now. I may increase the size of my position back up to 3 or 4%.
Risks
What could possibly go wrong? I think a lot that could go wrong has already happened, resulting in a 45% drawdown in the stock, which is the largest in at least the last 20 years, according to Koyfin.
First, I never like when companies put out long-term targets, as it typically leads to disappointment, in my experience. I prefer companies that do not provide any guidance or stick to a quarter or year out.
Above is Nike’s FY25 targets compared to actual results. One can see that Nike Direct, Nike Digital, China growth, gross margin, EBIT margin, and EPS growth are all off the mark. Management quickly removed any mention of FY25 targets from its filings and earnings call dialogue as soon as it started underperforming. The bad news is that management said they are going to release another five-year outlook at its next investor day. Yikes!
Next, I worry about competition, especially from Deckers (HOKA) and Lululemon. See the stock price comparison above from Finchat.io. Over the last ten years, Nike returned less than 200% compared to Deckers’ ~1,000% and Lululemon’s ~700%. When going to the gym, I see HOKA, Lululemon, and ON more and more every day. Is this just another trend, like with Adidas and Kanye, that will pass? Or are these newer brands here to stay? Nike has fought off trendy brands in the past (Under Armour) and proved to be a long-term winner. Is this the end for Nike? Tiger Woods left Nike recently, but what about the German football team switching from Adidas to Nike? There is good discussion of my demand creation category in that article:
"The DFB is also looking for an internationalization strategy in marketing, and I can imagine that Nike could provide a bit of a global tailwind; even the Nike ecosystem could be more interesting worldwide, across sports, than Adidas," Vöpel said. "I think it's possible that such considerations could have played a role."
It seems to be like most competition shows up for a year or two, while Nike dominates in the long-run.
Nike is so far ahead of competitors, in terms of sales, that it is difficult to read who’s who in the chart above. One can see brief, rapid increases at UAA, then Adidas and Puma, and now Deckers, but Nike is the one consistent growth company. Adding up the total sales for these companies, Nike has close to 50% of all sales! This gives me confidence in Nike in the long-run despite competitive headwinds that show up every few years.
Last, I am concerned about Nike’s exposure to China which has been a high-risk market in recent years. China is Nike’s second most profitable geography after North America in terms of EBIT dollars (it is the most profitable by EBIT margin at 30%), and was supposed to be the fastest growing geo. However, this has not played out due to the pandemic and economic conditions in the country. China still has potential to be a large athletic market in the future.
To conclude, Nike scores a 19/25 in my latest review of the company. See where it stacks up with the other companies I follow, now on Tableau!
Thank you for reading! Please share your thoughts below.
Holdings Disclosure
At the time of this publication, Mark Hogan owns shares in Nike $NKE while I (YZ) don’t.
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Disclaimer from Mark Hogan
Please see my holdings disclosure located in the Google Sheets link.
Any views or opinions are my own. I do not represent a firm. I am not giving financial advice. The stocks that I write about could increase in value, lose value, or stay the same value. Investing involves risk and losses can occur. Some stocks I write about may not be appropriate for you and you should consult a professional investment advisor. Data presented is from sources I believe to be reliable. The opinions and commentary presented reflect my best judgement at this time and may include “forward-looking statements”, all of which are subject to change at any time without obligation to update them. Actual future results may be different than my expectations.
This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, the author has not independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author assumes no liability for this information and no obligation to update the information or analysis contained herein in the future.
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Seems like I can’t comment on other’s comments (unfortunately) thank you for kind works @StockOpine and @TheWeekendInvestor
Great job 👏🏻