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Even if we invest in a great company, not every investment decision we make ends up being a wise one. We should, however, at least give ourselves a fighting chance of generating a decent investment return. Case in point? Nike (NKE). Pay attention to Nike's valuation otherwise you risk disappointment.
NKE is a great company that is likely to continue to be an industry leader for years to come. However, investors should (at the very least) ask themselves how a company whose shares traded in the low $90s at the end of September could be worth in the low $120s by mid-December. Did something about the company fundamentally change in a span of less than 3 months!?
In my September 29 post, I disclosed the purchase of additional shares at ~$90 bringing my NKE exposure to 722 shares in a 'Core' account within the FFJ Portfolio; NKE's valuation at the time was appealing.
On November 9, I concluded my guest post at Dividend Power with the following:
As much as I like NKE as a long-term investment, I TRY to acquire shares in great companies when they encounter a ‘speed bump’ and many investors are ‘heading for the exits’.
After a recent brief period where the share price of so many companies hit a new 52-week low, craziness has returned. Looking at NKE’s current valuation, I am hesitant to add to my exposure and will bide my time.
When I composed that post, NKE's share price had risen to ~$107 and I thought NKE was too expensive to further add to my exposure.
Following that post, NKE's share price marched higher to the low $120s. I did not like NKE's valuation at ~$107 and even less in the low $120s.
As I compose this post on December 22, we now have NKE's Q2 2024 results. Clearly, investors are not impressed and the share price has been knocked back to ~$108.
Let's revisit NKE's valuation.
Business Overview
The best resource from which to learn about NKE is Part 1 Item 1- Business in the FY2023 Form 10-K. In this section, we get 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 that may currently exist or which could materialize. Item 1A – Risk Factors in the Form 10-K runs from page 12 to page 26!
CEO and NEO Compensation
I reference my guest post at Dividend Power where I address executive compensation.
Financials
Q2 and YTD2024 Results
The most recent results are accessible in this Earnings Release; the Q2 2024 Form 10-Q is currently unavailable.
One area catching investor attention in recent quarters is NKE's inventory levels. At the end of November 2022, NKE's inventory was ~$9.3B. This has since been reduced by ~14% to just under $8B at the end of November 2023. This reduction is partially attributed to NKE's proactive decision to liquidate excess inventory. Although price reductions dampened reported revenue growth through Q2, total retail sales in the quarter grew across the marketplace on top of double-digit growth in the prior year.
Receivables of ~$5.4B at the end of November 2022 likely made some investors wonder about NKE's exposure to financially challenged retail operators. NKE's accounts receivable were ~$4.8B at the end of Q2 2024 which is encouraging. However, NKE's earnings release provides so little information that it is difficult to ascertain the extent of its bad debts.
On a positive note, NKE's higher-priced products have been resilient and markdown rates are lower than many competitors.
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 so it is difficult to determine YTD Free Cash Flow (FCF). In Q1 2024, however, NKE’s Cash used by operations was $66 million. Additions to property, plant and equipment amounted to $0.253B. This resulted in a Q1 FCF deficit of $0.319B.
Investors should not read too much into this deficit and should expect NKE to generate FCF comparable with historical levels.
FY2024 Guidance
On the Q1 2024 earnings call, management highlighted a number of risks including:
- the effects of a stronger U.S. dollar on foreign currency translation;
- consumer demand over the holiday season; and
- NKE's second half wholesale order books.
NKE sees indications of more cautious consumer behavior around the world. Total retail sales across the marketplace fell short of expectations. While NKE's store traffic continued to grow, there was softness in digital traffic and higher levels of promotional activity across the marketplace. As a result, it is adjusting its channel growth plans for the remainder of the year and is reducing marketplace supply of its key products.
Since FY2019, NKE's Consumer Direct has added tens of millions of new members to the company's member base and has delivered $12B+ of incremental revenue. Added complexity and inefficiency, however, has also been created.
In this competitive environment, NKE needs to invest to accelerate the next phase of innovation, growth and profitability. To this end, NKE has identified opportunities to deliver up to $2B in cumulative cost savings over the next 3 years. Examples include:
- the simplification of product assortment;
- supply chain efficiency improvements;
- lowering the marginal cost of operations;
- increasing automation and speed from data and technology;
- streamlining the organizational structure that includes a reduction in management layers; and
- enhancing procurement capabilities.
Now that the impact of the risks highlighted in the Q1 2024 earnings call are clearer, NKE is adjusting its FY2024 financial outlook as follows:
- Q3 reported revenue is likely to be slightly negative in comparison to double-digit growth in Q3 2023;
- Q4 reported revenue is likely to be up low single digits; and
- FY2024 reported revenue growth expected to be ~1%.
This new outlook reflects amongst other things, the increased macro headwinds, particularly in Greater China and Europe, Middle East, and Africa (EMEA).
Gross margin expansion is forecast for the second half of FY2024 with Q3 margins expanding 160 - 180 bps and Q4 margins expanding 225 - 250 bps.
FY2024 gross margin expansion of 140 - 160 bps reflects benefits from strategic price increases, improved ocean freight rates and supply chain efficiency, partially offset by higher product input costs and a ~60 bps impact from foreign exchange headwinds.
Credit Ratings
NKE's $8.930B of long-term debt at the end of Q2 is similar to the $8.929B of long-term debt reported in its Q1 2024 Form 10-Q. It is also almost identical to the long-term debt owed at NKE’s May 31, 2023 fiscal year end (see long-term debt schedule below).
Source: NKE - FY2023 Form 10-K
We see from this schedule that NKE is borrowing at VERY attractive rates. Furthermore, the scheduled maturity suggests that NKE should easily be able to retire its obligations.
Moody’s assigns an A1 rating while S&P Global assigns an AA- rating to NKE’s domestic senior unsecured long-term debt.
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
Currently, the dividend history reflected on NKE's website is outdated and so is that reflected on this site.
In my November 9 guest post at Dividend Power, I stated:
Looking at NKE’s recent dividend increases, it is not unreasonable to envision a ~$0.03 increase in mid-November. If this materializes, the next 4 quarterly dividends will amount to ~$1.48 ($0.37 x 4). Using the current ~$107 share price, the forward dividend yield would be ~1.38%. The projected dividend yield based on my September 27 ~$90 purchase price, however, is ~1.64%.
On November 14, NKE announced that its Board approved a quarterly cash dividend of $0.37/share on the outstanding Class A and Class B common stock. This represents an ~8.8% increase from the prior quarterly dividend rate of $0.34/share. This new dividend is payable on January 2, 2024 to shareholders of record at the close of business December 4, 2023.
While this marks the 22nd consecutive year in which NKE has increased its dividend, dividend metrics are of little relevance in my investment decision-making process. My interest lies in an investment’s TOTAL potential shareholder return. I would much rather a company retain funds or repurchase attractively valued outstanding shares if these methods of capital allocation will generate superior returns than what could be attained from dividend distributions.
With shares currently trading at ~$108, the forward dividend yield is ~1.37%.
NKE has been a prolific buyer of its issued and outstanding shares.
Throughout FY2023, NKE repurchased 50 million shares for $5.5B. Of this total, 6.5 million shares were repurchased for $0.7B under the previous four-year, $15B program approved by the Board in June 2018. The remaining 43.5 million shares repurchased for $4.8B were retired under the current four-year, $18B program approved by the Board in June 2022.
In Q1 2024, NKE repurchased $1.1B, reflecting 10.5 million shares retired as part of the current 4 year $18B share repurchase program the Board approved in June 2022.In Q2, it repurchased 11.9 million shares for a total of ~$1.2B.
As of November 30, 2023, a total of 65.9 million shares have been repurchased under the program for a total of ~$7.1B. For comparison, NKE had repurchased 54 million shares under the program for a total of ~$5.9B as of August 31, 2023.
The weighted average number of outstanding shares in FY2011 – 2023 (in millions rounded) is 1,943, 1,879, 1,833, 1,812, 1,769, 1,743, 1,692, 1,659, 1,618, 1,592, 1,609, 1,611, and 1,570. The diluted weighted average common shares outstanding in Q1 2024 were reduced to ~1,543.3 and ~1,532.1 in Q2 2024!
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 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 guest post. Broker estimates, however, are very similar to when I purchased my shares
- 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.
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.
Shares now trade at ~$108 as I compose this post. The following are the current broker estimates but I anticipate these will be lowered slightly over the next several days.
- 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.
It is important to pay attention to Nike's valuation. Currently, its valuation is even less desirable than when I wrote my November 9 post!
Final Thoughts
My final thoughts are the same as when I wrote my November 9 guest post at Dividend Power.
Based on management's current FY2024 guidance and the current broker estimates, a price in the low $90s is the level at which to acquire NKE shares.
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.
