Nike Inc

Slightly overpriced with low potential given the challenges ahead

Disclaimer:

The information provided in this blog is for informational purposes only and should not be considered as financial, investment, or professional advice. The valuations and analyses presented here are based on publicly available information and our interpretation of such data.

More than a year ago, Nike Inc. grabbed my attention when its stock fell from the 2021 all-time high of $180/sh to $80-90/sh in October 2022.

I had previously been a shareholder during the pandemic when Mr. Market offered the greatest sports apparel company at $60/sh. That investment was quite easy because the stimulus from central banks boosted the demand for almost everything. In addition, the company was investing in the metaverse, which, back then, was going to change our lives (I’m still waiting…). I sold it in 2021 when multiples made no sense at all.

In retrospect, investing during the downturn of the lockdown was a mistake because no one could be sure that there would be strong consumption over the next few months or years. Fortunately, it worked out well.

A year ago, Nike Inc. was trading at $90 again. I wanted to look at it and missed it because, in a matter of a few weeks, it was already at $110. Now, the market is offering it again at $100.

Since 2022, the economic situation has become very complicated for the retail sector. Although the economy remains relatively strong, some sectors have been hit hard. One of them is retail, where inflation has eaten away all its margins.

Remember how in 2021, consumption was very strong, which caused Nike's inventories to grow significantly. As can be seen in the graph, due to the over-demand resulting from central bank policies, the company overestimated its expectations, and when inflation broke out and central banks raised rates, consumption slowed down and inventories soared above the levels of confinement.

Since then, Nike and other retailers have been proactively taking steps to liquidate this excess inventory. This involves a price war among all brands, which is also being joined by the wholesale segment. Therefore, we are currently in an environment of a lot of promotional activity in the marketplace and macro headwinds in EMEA and China, two key regions.

All this has brought the share price back to what optically seem to be interesting levels.

The big question: Is Nike a good opportunity at the current levels?

Before answering the question, it is important to understand the current market environment and how Nike has performed in the last quarters.

Performance over the last 6 months has been weak, with revenues growing by just 1%. The main factors remain the ones we commented above: promotional activity in the marketplace and macro headwinds in EMEA and China.

• US: The company faced two consecutive quarters of revenue decline: -1.6% and -3.5%. Growth in the US is critical as it’s Nike’s biggest segment.
  Management expects promotional activity to continue both in stores and digital channels, thus growth should remain weak in the near term.

• China: Compared to regions such as the US or EMEA, where penetration is higher, revenue in China presented very modest growth in the last years. The company grew at c.4% in the last 6 months. The results were affected by negative impacts from FX.

The performance has been weak compared to the estimates from the investment community. When the company reported a growth of just +1% in revenues, with revenue in the US declining again, the stock plummeted 10% in a day. This is what matters in the stock market. A good performance is not equal to a higher share price. The price of a stock has already incorporated expectations and assumptions.

If I were a Nike shareholder, I wouldn’t worry about the operating performance of the company. After the Fed initiated the most aggressive tightening cycle in decades, the retail sector is facing expected strong headwinds. These cycles don’t last forever and being able to grow +1% is a clear signal that the company can perform extremely well under normal conditions.

The main problem is the valuation.

Nike is a stock that always trades at really high multiples and offers few opportunities. I believe we are not in a great buy opportunity. Why?

Valuation for next year’s earnings is between 25x and 30x. I don’t think the stock will have a re-rating to above levels and, given today’s challenges of the industry paying 25-30x is simply too much.

The operating margins of the company, currently at 11-12% do not justify such a high valuation. Although management expects to recover and reach higher margins, these margins represent a highly competitive market where pricing power is only limited to the most premium products.

The rest of the market, especially non-premium apparel can be considered more as a commoditized market. This brings me to the fact that:

• I don’t like markets with huge competition. Nike competes against a wide list of retailers such as Adidas, Asics, Under Armour, ON, Puma, New Balance, Vans, etc.

• There is little room for pricing power, which is only limited to premium products. The end consumer has some bargaining power as technologies among competitors are quiet similar

• Little room to add new markets and, when added, all other players come. As an example, the hiking segment is being targeted by Nike, Adidas, etc. limiting the growth from new opportunities

• Market leaders find difficult to maintain dominance as competitors will maintain strong innovation

As we’ve done with other companies, I’ve done our company research and we have our valuation models ready to be updated in case I see there is an opportunity in the future.

This is what you find when you enter a specialized retailer: hundreds of shoes and multiples brands to choose. Very difficult to differentiate in this environment

Reasons not to invest in Nike:

1. Valuation is too high: 25x-30x next year's earnings, and the stock needs to remain above 25x in the future to create value. The value with a DCF offers a low potential upside of 25%. I’m not paying a very high multiple unless the business is rock-solid, which I doubt for the following reasons:

2. Increase in competition: The sector is highly competitive, and it is becoming very difficult to grow in the key sectors. Companies are diversifying into sectors like hiking, but these are not as big markets as running, football, etc.

3. The competitive environment can be seen in the US, where sales are declining for the second consecutive quarter.

4. Low pricing power: While the company managed to significantly increase revenues, margins are down by 2-3%, implying a difficult environment when prices increase.

5. Not a growth stock: Despite Nike promoting itself as a growth stock, I believe the current market offers fewer growth opportunities to incumbents, who will remain challenged by new players such as On Running, Hoka, etc.

6. Headwinds in China: The trade wars, plus a strong dollar vs. the Chinese Yuan, will make it hard to grow in China, which should be a key contributor to future growth.

To conclude, Nike Inc. is a great company. I will definitely own the stock if it were trading at reasonable valuations.

We are entering the most important results period of the year, where companies will discuss the current market situation. The stock might continue to face downward pressure. If it happens and valuation reaches a reasonable price, I will invest.

While I’m not going to write a post for every stock I reject to invest in, I think sometimes it helps to define an investment process and to avoid falling into the traps that many graphs throw up.

If you want to learn about our first investment, take a look at the post I wrote about Novem Group

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