Despite increased competition Nike, Inc. (NKE) stands to benefit from the growing global middle class.

I view NKE as an attractive long-term investment in that it consistently generates strong Free Cash Flow and has a Balance Sheet which reflects minimal Intangible Assets and Goodwill.

 

Summary

  • NKE faces stiff competition but it has demonstrated that it can adapt in a highly competitive environment (annual revenue of ~$8.777B, ~$19.176B, and $39.117B in 1999, 2009, and 2019).
  • NKE can certainly be negatively impacted by ongoing trade tensions but only 18% and 13% of NKE’s factories and employees are based in China.
  • Should the US/China trade dispute not be resolved in short order, NKE could possibly shift production to Vietnam or Indonesia but this is not a decision NKE would take lightly.
  • NKE expects digital commerce, owned and partnered, to comprise at least 30% of its business by 2023 and in the longer term, NKE sees digital driving the majority of its business.

Introduction

Although I have written recent Nike, Inc. (NKE) articles (here and here), NKE has released its Q4 and FY2019 results following the June 27th market close. In this article I look at whether NKE’s current valuation warrants the purchase of additional shares.

I currently hold NKE shares in the Core portion of the FFJ Portfolio. On April 16, 2019 I wrote 5 September 2019 $92.50 covered calls which generated $3.14/share before commission. My rationale for writing these calls was to generate additional income. I chose this strike price because I did not expect NKE’s share price would rise to this level prior to expiry.

While NKE faces significant competition, it has demonstrated over a prolonged period of time that it can grow market share and maintain premium pricing. When I initiated a NKE position on June 27, 2016 I looked at NKE’s intangible brand asset and came to the conclusion that NKE would be able to command premium pricing and to continue to be profitable well into the future.

My opinion of NKE as a long-term investment improved further when in mid-2017 NKE announced its Triple Double strategy to double innovation, speed, and direct connections to consumers; I discussed this strategy in my November 20, 2017 Nike Stock Analysis – Great Long-Term Upside Potential article. The intent of this strategy is to cut product creation times in half, increase membership in NKE’s mobile apps, and to improve the selection of key franchises while reducing the number of styles by 25%.

Subsequent to the launch of the Triple Double strategy, NKE has invested heavily in its direct-to-consumer network and has purposely reduced its reliance on retail partners. NKE has exited its relationship with retail partners it has identified as being mediocre and has increased its focus on such retailers as Dick’s Sporting Goods, Nordstrom, and Foot Locker. NKE now operates its own shops with its own salespeople. This provides NKE with greater control over its brand.

NKE has also identified China and other emerging markets as key growth regions. In my November 20, 2017 article I discussed NKE’s 4 regions:

  • North America (NA)
  • Greater China (GC)
  • Europe, Middle East & Africa (EMEA)
  • Asia Pacific and Latin America (APLA)

and indicated that international markets represented ~55% of NKE’s business with this level projected to grow.

In fact, in each of the last 4 fiscal years NKE has experienced double-digit growth in China and this level of growth is expected to continue for at least another decade as the Chinese government invests heavily in sports. In fact, on the June 27, 2019 Q4 2019 conference call with analysts, NKE’s Chairman, President, and CEO stated:

‘Our Greater China business is the blueprint for how all those dimensions come together. We added more than $1B of incremental growth in the geography this past year. We are and remain a brand “of China, for China.” Nike is proud of the investments we’ve made and the relationships we’ve developed in this energizing marketplace. And we’re confident that we’ll continue to grow sport and our business in China for decades to come.’

In FY2019, NKE doubled the percentage of total revenue generated by recently launched innovation platforms relative to FY2017.

Nike Direct drove ~50% of incremental revenue growth in FY19 with Nike Digital growing 35% for FY2019.

NKE expects digital commerce, owned and partnered, to comprise at least 30% of its business by 2023 and in the longer term, NKE sees digital driving the majority of its business.

NKE, with worldwide distribution and $3B+ in FY2019 digital sales also stands to benefit as the middle class grows in China, India, Latin America, and other regions and gain broadband access.

On the tariff issue, NKE factories in China produce ~26% of NKE’s footwear and apparel. Any trade dispute between US/China which increases barriers to trade would most likely lead to higher costs and would likely be detrimental to NKE. I note, however, that NKE has 109 factories and 144,250 employees in China which only represents 18% and 13% of NKE’s global operations.

If you look at NKE’s Manufacturing Map you can see that NKE has global operations so if it needed to shift production to other countries, I envision NKE could go in this direction. This certainly would not be easy and would not happen overnight but if the US/China trade dispute drags on and the probability of a resolution becomes increasingly unlikely I envision NKE might consider shifting some of its production out of China to the likes of Vietnam or Indonesia, for example.

Q4 and FY2019 Results

On October 14, 2015, NKE provided an overview of its progress on key strategic initiatives to achieve sustainable, profitable long-term growth and announced a revenue target of $50B by the end of FY2020. Additionally it shared its long-term financial model of high single-digit to low double-digit revenue growth, mid-teens earnings per share growth and expanding returns on invested capital.

Looking at NKE’s most recent results found here and here it would appear that NKE may fall short of its revenue target given that FY2019 Revenue slightly exceeded $39B. I am not concerned that NKE may not reach this top line growth target and view the ~$8.4B top line growth from FY2015’s ~$30.6B as a sign that NKE has not lost its ability to grow despite stiff competition from the likes of Adidas, VF’s Van’s, Lululemon, Under Amour, etc.. NKE also faces competition in China from native brands like Anta Sports Products.

Subsequent to the October 2015 announcement, NKE’s management communicated at its October 2017 Investor Day that its new ‘Consumer Direct Offense’ would generate high single digit revenue growth on average over the next 5 years. With FY2019 being the first full year in which NKE has executed this strategy, revenue grew 11% on a currency neutral basis, and 10% in Q4; this is ~$4B of incremental Revenue in just one year.

Looking at NKE’s results we see that growth has been broad-based with all four Geographies growing at or above long-term targets.

On the Q4 conference call with analysts, management indicated that 18 months ago, it appeared that harmonized global growth was beginning to turn foreign exchange into a slight tailwind. Geopolitical dynamics over the past year, however, have led to the strengthening of the US dollar…fueled largely by uncertainty around Brexit and US/China trade.

Management knows that the foreign exchange headwinds of late may be short-lived, and therefore, it continues to remain focus primarily on what it can control to execute its strategy.

FY2020 Guidance

FX headwinds have intensified over the past couple of months but NKE’s currency neutral outlook continues to improve and it is reiterating FY2020 guidance.

FY2020 Revenue growth remains in the high single digit range which slightly exceeds reported Revenue growth in FY2019.

Currency headwinds may reduce NKE’s Q1 Gross Margin. FY2020 Gross Margin, however, is expected to expand and could potentially approach 50 bps even though FX and strategic supply chain investments, such as RFID and expanding Air Manufacturing Innovation will create a roughly 50 bps headwind.

Free Cash Flow

In addition to the pleasure of analyzing a Balance Sheet with negligible Identifiable Intangible Assets and Goodwill, investors can take some comfort that NKE has a track record of generating significant Free Cash Flow. Between 2009 and 2018, NKE generated the following annual FCF results:  $1.313B, $2.839B, $1.381B, $1.263B, $2.448B, $2.136B, $2.266B, $2.754B, and $3.93B.

I do not see any reason why NKE would fail to continue to generate significant FCF in the coming years.

Credit Ratings

There has been no change to NKE’s credit ratings subsequent to my previous NKE article. Moody’s still rates NKE as A1 and S&P Global still rates it AA-. Moody’s rating is the top tier of the upper medium grade. S&P’s rating is the lower tier of the high grade.

These ratings are acceptable from my perspective and I have no reason to believe my current NKE investment is at undue risk.

Valuation

In my September 26, 2018 NKE Stock Analysis article I indicated:

On September 25th, prior to the release of Q1 results, NKE closed at ~$84.80. On September 26th, NKE closed at ~$83.75. Using the current $2.66 consensus adjusted EPS from 35 brokers for FY2019 I arrived at a forward adjusted PE of ~31.5.

At the time, projected adjusted earnings for FY2020 from 34 analysts was $3.14. Using the ~$83.75 share price I arrived at a forward adjusted PE of ~26.7.

When I wrote my March 22, 2019 article, the Consensus adjusted EPS from 34 analysts for FY2019 was $2.58 and $3.08 for FY2020 from 35 analysts. With NKE trading at ~$82.19 and FY2019 guidance of $2.58, the projected adjusted diluted PE was 31.86. The projected adjusted diluted PE using FY2020 estimates was ~26.69.

I now see that the mean adjusted EPS guidance from 30 analysts is $3.00 with the low and high estimates being $2.90 and $3.13. Using the June 28, 2019 closing stock price of $83.95 and the adjusted EPS guidance from analysts I arrive at a forward adjusted PE range of ~26.82 - ~28.95. I view this range as fair.

Dividend, Dividend Yield, and Dividend Payout Ratio

NKE’s dividend history can be found here.

On July 1, 2019, NKE will be distributing its 3rd $0.22 quarterly dividend.

Based on the current $83.95 stock price, NKE has a forward dividend yield of ~1.05% which is comparable to the 1.07% level at the time of my March 22, 2019 article and slightly higher than the 0.96% level at the time of my September 26, 2018 article.

I envision NKE will distribute its 4th $0.22 quarterly dividend at the beginning of October and will then increase the quarterly dividend to $0.24 which would be consistent with recent dividend increases. On this basis, investors should expect the next 4 dividends to total $0.94. Using the current $83.95 share price we then get a forward dividend yield of ~1.12%. While not an attractive yield, NKE investors should view NKE as a growth stock versus a dividend income stock.

Using the projected $0.94 dividend and the $3.00 mean adjusted diluted EPS guidance from 30 analysts we get a payout ratio of ~31.3%. Even if NKE’s adjusted diluted EPS for FY2020 were to come in at $2.90 (the low end of guidance) the dividend payout ratio would be ~32.4%. I have little reason to be concerned that NKE’s dividend would be at risk.

A dividend payout ratio in the low 30% range is consistent with recent historical levels.

Share Buybacks

NKE has reduced its share count by ~20% over the past decade and I expect it will repurchase more than $20B over the next 5 years.

In FY2014 the weighted average common shares outstanding amounted to 1.81B. This has been reduced to 1.618B for the fiscal year which ended May 31, 2019.

The repurchase of shares is now being done under the 4 year $15B stock repurchase program NKE’s Board authorized in June 2018.

Final Thoughts

In FY1999 and FY2009 NKE generated ~$8.777B and ~$19.176B in annual revenue. In FY2019, NKE generated $39.117B in annual revenue. If there is any doubt that NKE’s market is saturated I think the growth in revenue addresses this concern.

More importantly, NKE is consistently profitable and it consistently generates strong Free Cash Flow.

Despite significant competition and current US/China trade tensions I think NKE has a bright future in that the rising number of people in the global middle class should act as a tailwind.

I currently hold NKE shares in the core component of the FFJ Portfolio. I view NKE to be fairly valued based on adjusted earnings projections and while I intend to acquire additional shares within the next 72 hours I have yet to decide in which account I will acquire additional shares.

I wish you much success on your journey to financial freedom.

Thanks for reading!

Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected]om.

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long NKE.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.