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I last reviewed Nike (NKE) in this December 22, 2023 post at which time I concluded that NKE's valuation did not warrant the purchase of additional shares.
Now that NKE has released its Q3 and YTD2024 results and FY2024 outlook on March 21, I revisit this existing holding.
In my opinion, the time to invest in a great company is when it experiences near term challenges and has fallen out of favor with many investors. NKE is such a company.
Business Overview
The best resource from which to learn about NKE is Part 1 Item 1 - Business in the FY2023 Form 10-K. This section provides a general overview of the company, its products, and markets amongst other pertinent information.
Learning about a company also entails an understanding of risk factors (Item 1A – Risk Factors in the Form 10-K) that may currently exist or which could materialize.
Financials
Q3 and YTD2024 Results
The most recent results are accessible in this Earnings Release.
NKE continues to experience headwinds which is leading to weak top line growth results.
NKE's Consumer Direct Acceleration Strategy has driven growth and direct connections with consumers. Management, however, recognizes the company must:
- sharpen its focus on sport;
- drive continuous flow of new product innovation; and
- work on its brand marketing so it becomes bolder and more distinctive.
While NIKE Direct will continue to play a critical role, NKE must work more closely with its wholesale partners to elevate the NKE brand and grow the total marketplace.
In recent quarters, NKE's inventory levels have been bloated. At the end of Q2 2023, NKE's inventory was ~$9.3B. This had been reduced by ~14% to ~$7.979B at the end of Q2 2024. By the end of Q3 2024, this had been further reduced to $7.726B; weeks of supply are currently at their lowest levels since the pandemic.
The changes from Q2 to Q3 in other Balance Sheet line items are not alarming.
Gross margin expanded 150 basis points (bps) to 44.8% from 43.3% in Q3 2023. This increase was driven by strategic pricing actions, lower ocean freight rates and improvements in supply chain efficiency. However, NKE experienced higher product input costs.
In addition, there was 50 basis points of negative impact from restructuring charges and Sales, General, and Administrative expenses grew 7% resulting from increased investments in demand creation. Sales, General, and Administrative expenses were also impacted by ~$0.34B in restructuring charges.
NKE's effective tax rate for the quarter was 16.5% versus 16% for the same period in the prior fiscal year.
Diluted EPS in Q3 was $0.77. Excluding the impact of the restructuring charges, EPS would have been $0.98, up 24% versus the same period in the prior year.
Free Cash Flow (FCF)
NKE is highly profitable and repeatedly generates strong Free Cash Flow ($1.261B, $2.434B, $2.133B, $3.717B, $2.256B, $2.741B, $3.927B, $4.784B, $1.399B, $5.962B, $4.43B, and $4.872B in FY2012 – FY2023).
NKE's YTD Consolidated Statement of Cash Flow is currently unavailable. It is, therefore difficult to determine YTD Free Cash Flow (FCF). NKE’s cash provided by operations, however, amounted to $2.751B. Additions to property, plant and equipment amounted to $0.458B. The difference of $2.293B represents the FCF NKE generated in the first half of FY2024.
FY2024 Guidance
NKE continues to drive earnings growth. Challenging business conditions, however, are likely to persist. Management's outlook includes the impact of higher markdowns and reduced benefits from channel mix due to franchise life cycle management and worsening foreign exchange headwinds.
Management continues to expect revenue to grow ~1%.
Disciplined cost controls and more productive inventory levels are expected to offset soft second half revenue so as to improve gross margin. Q4 gross margins are expected to expand ~160 - ~180 bps as a result of benefits from strategic price increases, lower ocean freight rates, lower product input costs and improved supply chain efficiency.
For the full year, gross margin is expected to expand ~120 bps. This includes ~60 bps of impact from foreign exchange headwinds.
In Q4, Selling, General and Administrative (SG&A) expenses are expected to be down slightly versus the prior year and to be an improvement from prior guidance. For the full year, SG&A is expected to grow low single digits. This is also an improvement versus prior guidance.
Excluding the impact of restructuring charges, however, full year SG&A is expected to be roughly flat. In addition, excluding restructuring charges, NKE expects to deliver on the FY2024 earnings outlook communicated at the beginning of the fiscal year.
Restructuring charges of ~$0.45B in the second half of FY2024 includes ~$0.403B incurred in Q3.
FY2025 Preliminary Guidance
On the Q3 earnings call, management shared some early thoughts on how the company is planning for FY2025.
Expectations are for revenue and earnings to grow versus the prior year, with operating margins expanding, excluding the impact of the restructuring charges in FY2024.
Revenue in the first half of FY2025, however, is expected to be down low single digits. This reflects near-term headwinds from life cycle management of NKE's key product franchises that more than offset the roll out of new products as NKE shifts its product portfolio toward newness and innovation.
The preliminary guidance also reflects the subdued macro outlook around the world.
Risk Assessment
On March 8, 2024, NKE entered into a Credit Agreement with various financial institutions. Details are provided in this Form 8-K. In reviewing this document, I see nothing that should alarm investors.
The Q3 2024 Form 10-Q is unavailable as I compose this post. The quarterly financial statements, however, typically do not include a schedule of NKE's long term debt. I, therefore, provide the schedule of NKE's long-term debt at FYE2023; the ~$8.93B long-term debt at the end of Q3 is very similar to what was outstanding at FYE2023.
We see from this schedule that NKE borrows at VERY attractive rates.
The long-term debt with a scheduled maturity of March 27, 2025 will shift to a current liability when NKE reports its results for FYE2024 (May 31). There is nothing to suggest that NKE will be unable to repay this credit facility. I am of the same opinion regarding the repayment of the $1B long term debt maturing in 2026 and 2027.
I think NKE will retire $3B of long term debt before FYE2027. This would lead to a ~$75.3 million reduction in interest expense; the average interest rate of the debt that matures in 2025 - 2027 is 2.51% ($3B x 2.51%).
This amount is relatively insignificant in the grand scheme of things but by FYE2027, NKE could have as little as $6B of long term debt. This could lead to an upgrade in its credit ratings.
Source: NKE - FY2023 Form 10-K
Moody’s continues to assign an A1 rating while S&P Global continues to assign an AA- rating to NKE’s domestic senior unsecured long-term debt. The outlook from both is stable.
Moody’s rating is the top tier of the ‘upper-medium grade’ investment-grade category. S&P Global’s rating is one notch higher at the bottom tier of the high-grade investment-grade category.
Moody’s rating defines Nike as having a STRONG capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
S&P’s rating defines NKE as having a VERY STRONG capacity to meet its financial commitments with its rating differing from the highest-rated obligors only to a small degree.
Dividend and Dividend Yield
When I last reviewed NKE, shares were trading at ~$108 and the forward dividend yield was ~1.37% ($0.37/share/quarter x 4).
On February 8, NKE declared its second consecutive $0.37/share quarterly dividend. The next quarterly dividend will most likely remain at $0.37 and its declaration will likely occur near the beginning of May.
I envision that in mid-November, NKE will declare a ~$0.03/share increase in the quarterly dividend. If this materializes, the total of the next 4 quarterly dividend payments (after the distribution of the April 1, 2024 dividend) will amount to $1.54 (($0.37 x 2) + ($0.40 x2)). Using the current $93.76 share price, the forward dividend yield is ~1.64%.
Dividend metrics, however, are of little relevance in my investment decision-making process. My preference is capital allocation that maximizes shareholder value; dividend distributions are not always the optimal menas by which to reward investors.
If dividend metrics matter to you, however, NKE has increased its quarterly dividend for 22 consecutive years.
NKE has been a prolific buyer of its shares. The weighted average diluted shares outstanding in FY2014 was ~1.812B and ~1.527B in Q2 2024.
In Q3, NKE repurchased ~7.9 million shares for ~$0.866B. These shares were retired as part of NKE's 4 year $18B share repurchase program that was approved by the Board in June 2022. As of February 29, 2024, a total of 73.8 million shares had been repurchased under the program for a total of ~$8B.
Valuation
NKE’s FY2012 – FY2023 diluted PE is 21.86, 26.75, 28.62, 30.34, 22.39, 27.08, 55.74, 35.42, 79.93, 43.75, 33.05, and 27.92.
In my September 29,2023 Nike Exposure Increased post at Financial Freedom Is A Journey, I disclosed my September 27 purchase of an additional 100 Nike (NKE) shares @ ~$90/share in a ‘Core’ account within the FFJ Portfolio. Using this purchase price and the adjusted diluted earnings broker estimates, NKE’s forward adjusted diluted PE levels were:
- FY2024 – 35 brokers – ~24.3 using a mean of $3.71 and low/high of $3.50 – $3.89.
- FY2025 – 34 brokers – ~20.7 using a mean of $4.35 and low/high of $3.81 – $4.82.
- FY2026 – 16 brokers – ~17.9 using a mean of $5.03 and low/high of $4.29 – $5.80.
NKE’s share price had surged to ~$107 when I wrote my November 9, 2023 guest post at Dividend Power. Broker estimates, however, are very similar to when I purchased my shares. I concluded that nothing had fundamentally changed from when I paid ~$90/share on September 27. The share price, however, had risen $17! We essentially went from ‘undervalued’ at the end of September to fairly valued.
- FY2024 – 31 brokers – ~28.8 using a mean of $3.72 and low/high of $3.50 – $3.89.
- FY2025 – 31 brokers – ~24.7 using a mean of $4.34 and low/high of $3.78 – $4.82.
- FY2026 – 13 brokers – ~21.4 using a mean of $4.99 and low/high of $4.26 – $5.80.
When I wrote my December 22, 2023 post, shares were trading at ~$108.
- FY2024 – 36 brokers – ~29.8 using a mean of $3.63 and low/high of $3.35 – $4.08.
- FY2025 – 36 brokers – ~25.2 using a mean of $4.28 and low/high of $3.73 – $4.79.
- FY2026 – 20 brokers – ~21.6 using a mean of $4.99 and low/high of $4.26 – $5.54.
Shares now trade at $93.76 as I compose this post. The valuation based on forward adjusted diluted earnings estimates from the brokers which cover NKE are:
- FY2024 – 28 brokers – ~26.2 using a mean of $3.58 and low/high of $3.44 – $3.92.
- FY2025 – 38 brokers – ~23.1 using a mean of $4.06 and low/high of $3.44 – $4.66.
- FY2026 – 26 brokers – ~20.4 using a mean of $4.60 and low/high of $3.54 – $5.45.
Final Thoughts
I look to acquire attractively valued shares of great companies. In the current environment, this often means that a company has likely fallen out of favor because it is experiencing near term challenges. NKE appears to be such a company. While the NKE brand remains strong, there are certainly headwinds contributing to the lackluster sale growth.
I think management is taking the appropriate action to defend its turf from the competition and to tightly control costs given that many consumers are experiencing financial strain.
Business, however, is cyclical and the time to be acquisitive is when a great company is on the ropes. Investing when valuations are rich often leads to poor total investment returns. At the same time, we don't want to invest in a company where money 'goes to die'.
Looking at NKE from a risk aspect, it already has very decent credit ratings from Moody's and S&P Global. If NKE repays ~$3B of long-term debt before FYE2027, I envision rating upgrades.
The company should also continue to generate strong FCF thus enabling it to repurchase shares as part of its capital allocation strategy. This leads me to think the weighted average number of diluted shares outstanding could drop from the current ~1.527B to ~1.45B by FYE2027. This 77 million reduction works out to ~26 million shares/year over the next 3 years. Hoepfully, NKE's share price will remain under pressure thus allowing the company to repurchase shares at favorable valuations.
I currently hold 725 NKE shares in a 'Core' account within the FFJ Portfolio. This will increase to 727 with the automatic reinvestment of the dividend income on April 1.
NKE was not a top 30 holding when I completed my 2023 Year End FFJ Portfolio Review and it will not become a top 30 holding despite my planned purchase of another 100 shares on March 25.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long NKE.
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.
