Contents
Summary
- After the market closed on September 25th, NKE reported Q1 FY2019 results and its share price pulled back ~4% in afterhours trading. The share price rebounded to close down only 1.25% on September 26th.
- The Federal Reserve increased rates 25 basis points on September 26th and a further increase is anticipated in December. If interest rates continue to increase, I suspect share prices, in general, will come under pressure.
- NKE shares appear to be overvalued based on projected earnings and I will patiently wait for a pullback before adding to my existing position.
Introduction
In preparing to compose this post I couldn’t help but think of Brookfield Asset Management’s CEO’s ‘Talks at Google’ presentation for which I provided a link in my September 23rd Brookfield Asset Management – Durable Principles for Real Asset Investing article. At 1:05 of that video presentation is an image of countless sheep marching in the same direction and falling over a cliff. Amongst all the sheep marching to their death is one sheep going against the crowd saying ’Excuse me…excuse me’.
How does this relate in any way to this Nike (NYSE: NKE) post? Well, if we look at NKE’s stock price we see that it has gained:
- ~3% since September 3rd when it released its controversial ad campaign featuring former NFL player Colin Kaepernick;
- 36% in 2018;
- ~59% in the last 12 months.
Sure, if NKE had dramatically increased earnings in such a short timeframe or if the stock price had been grossly undervalued a year ago, or at the beginning of the calendar year, then growth to the extent reflected above might be justified. The thing is, NKE has increased earnings and is on track to experience further growth but not to the extent one would expect to justify a significant share price increase.
At the time of my March 24th post, NKE had just reported $0.48/share in diluted EPS on March 23rd for the first 9 months of the fiscal year versus $1.91/share for the previous fiscal year. This deterioration in EPS from the previous fiscal year’s first 9 months was attributable to a significantly higher income tax expense from the enactment of the Tax Cuts and Jobs Act (TCJ); the 9 month results included one-time provisional charges that reduced diluted earnings per share by $1.25 to ($0.57)/share for the 3 months ending February 28, 2018.
At the time of that post, the consensus forward adjusted EPS estimate from 37 brokers for FY2018 was $2.35. When I used the March 23rd $64.63 closing stock price, I arrived at a forward adjusted PE of ~27.5 and viewed this as a somewhat elevated level.
When year-end results were released June 28th, NKE reported $1.17 in diluted EPS and $2.38 in adjusted diluted EPS; shares closed at $71.70 on June 28th. On this basis, NKE’s PE was ~61.28 or ~30.1 on an adjusted basis.
Now that NKE shares have risen significantly subsequent to March 24th and June 28th and Q1 FY2019 results have just been released I thought I would take a quick look at NKE to see whether many investors are like the countless sheep in the video presentation I reference at the beginning of this article…granted marching to their death is a bit extreme. The message I want to impart by referencing this image is that as an investor, it is often advantageous to go against the crowd.
Q1 2019 Results and Forecast
NKE’s Q1 2019 result can be found here and here.
Revenue increased 10%, up 9% on a currency-neutral basis with double-digit growth in NKE’s international geographies, 6% growth in North America, and NIKE Digital up 36% for the quarter.
On a currency-neutral basis, NKE reported stronger, more broad-based momentum around the world than the expectations set at the beginning of the current fiscal year. International markets continued to experience strong growth with Greater China growing at 20%.
On the gross margin front, NKE’s tighter supply and demand management resulted in a ~50 basis points gross margin expansion in Q1.
Operating overhead increased 5% due to investments in digital capabilities, as well as in NKE’s supply chain and enterprise technology platforms.
On the September 25th conference call with analysts, management indicated that NKE has become the leading brand in EMEA but there is further growth potential.
In Greater China, NKE has delivered 17 consecutive quarters of double-digit revenue growth; Q1 growth was 20% on a currency-neutral basis, fueled by Sportswear, Jordan, Basketball and across Women’s and Young Athletes.
While NKE’s strong start to the current fiscal year is greater than anticipated, NKE’s management raised the point that global trade uncertainty and geopolitical dynamics have resulted in the strengthening of the USD and FX shifting to a slight headwind over the past 90 days. Taking into account these dynamics, NKE is maintaining its full year guidance for FY2019 with revenue growth at the lower end of the high single digits. Gross margin is expected to expand 50 basis points or slightly greater, SG&A to grow in the high single digits and the effective tax rate to be in the mid teens.
Q2 Guidance
On the September 25th conference call management explained how FX impacts NKE’s financials on a short-term basis.
Revenue in NKE’s P&L is essentially unhedged which means NKE’s reported real dollar revenue growth reflects nearly all currency movements real time.
While NKE has a robust hedging program that delays the impact of FX on its profitability for 12 - 24 months, it is not economical to hedge FX risk in many emerging markets such as Turkey, Argentina, and Brazil; NKE only partially hedges its exposure to China.
NKE’s focus is to sustain strong, currency-neutral operating momentum over the longer term. In this regard, in Q2 NKE expects strong currency-neutral revenue growth in line with the 9% currency-neutral revenue growth delivered in Q1.
With gross margin, NKE expects less gross margin expansion in the first half of the year, as compared to the second half of the year.
In Q2, SG&A growth is expected to be in the low-teens driven by the timing of investments in sports marketing, including the kick-off of the NBA and NFL seasons, and the timing of strategic investments in new digital capabilities.
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
Given the gain in NKE shares reflected at the Introduction section of this article, it is not surprising that NKE’s valuation has increased dramatically over the past several months.
This chart reflects NKE’s PE ratio for FY2013 – FY2018 on the basis on the stock’s high and low stock price in each fiscal year.
Source: Data from NKE 10-Ks
As previously noted, when year-end results were released June 28th, NKE reported $1.17 in diluted EPS and $2.38 in adjusted diluted EPS. With shares having closed at $71.70 on June 28th, I felt NKE’s diluted PE of ~61.28 and adjusted diluted PE of ~30.1 were excessive.
On June 29th, the consensus FY2019 adjusted EPS estimate from 34 brokers was $2.66 thus giving us a forward adjusted PE of ~26.95.
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, we arrive at a forward adjusted PE of ~31.5.
If I thought NKE was overvalued when I wrote my March 24th article then I find NKE’s shares to be even more overvalued now.
Projected adjusted earnings for FY2020 from 34 analysts is $3.14. Using the current ~$83.75 share price we get a forward adjusted PE of ~26.7. This level is closer to recent historical levels.
The Federal Reserve raised interest rates by 25 basis points on September 26th, as widely anticipated, and indicated its intent to tighten once more in December. If it continues to raise rates further in 2019, I suspect stock prices in general will come under pressure thus providing investors with an opportunity to acquire NKE shares at a superior valuation relative to the current level.
NKE’s dividend history can be found here. Its 3rd quarterly $0.20/share dividend will be paid October 1st.
Based on the September 26th ~$83.75 closing stock price, NKE has a forward dividend yield of ~0.96%. Yield hungry investors will likely pass on NKE. In my opinion, a well diversified portfolio should hold shares in high quality companies and an investment decision should not be based almost exclusively on dividend yield.
NKE’s FY2018 dividend payout ratio of ~67% ($0.78/$1.17 in diluted EPS) was distorted because of the significantly higher income tax expense from the enactment of the TCJ which resulted in one-time provisional charges that reduced diluted EPS by $1.25. Without this one-time charge, NKE’s dividend payout ratio would have been in line with its track record of a sub 30% dividend payout ratio.
NKE’s stock split history can be found here.
In my March 24th article I mentioned that management had indicated that as a result of the TCJ, it expected to have more efficient access to capital which would enable it to complete its existing 4-year $12B share repurchase program within FY2019 (~1 year earlier than originally planned); as of February 28, 2018, a total of 126.4 million shares had been repurchased under this program for approximately $7.2B.
In Q1 2019, NKE repurchased a total of 17.8 million shares for approximately $1.4B and as of August 31, 2018, a total of 167.2 million shares had been repurchased under its share repurchase program for approximately $10.1B.
In June 2018, the Board of Directors authorized a new four-year $15B share repurchase program that will commence upon the completion of the current program.
Final Thoughts
I view NKE as an excellent company worthy of being held for the long-term in a well diversified portfolio. My concern is that NKE’s current valuation appears to be somewhat lofty even when we take into consideration the positive impact of NKE’s new $15B share repurchase program.
I would like to add to my existing 508 shares which are held in the FFJ Portfolio but I view a price of ~$72 or below as being more reasonable than ~$83.75; I think waiting for a PE similar to the low PEs of 2013 – 2017 will be an extremely long wait and a PE closer to the 2013 – 2017 high PEs is more realistic.
I recognize this may seem somewhat optimistic but as noted in the Valuation section of this article, if the Federal Reserve continues to increase rates I think stock prices in general will come under some pressure. Furthermore, it remains to be seen to what extent the recently imposed trade tariffs (and reciprocal trade tariffs) will have and whether trade wars escalate. Even though NKE should be able to raise prices and be less affected than retailers which sell private-label brands or lack the ability to raise prices, I can’t help but envision NKE not being negatively impacted to some extent (refer March 19, 2018 letter to the US President from leading American footwear companies and brands).
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].
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: 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.
