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.

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Disclosure: I am long NKE.

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