Nike faces challenges – GuruFocus.com

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Nike Inc. (NKE, Financial) is the largest athletic footwear and apparel company in the United States with worldwide revenue of approximately $49 billion.

Under the Nike Jumpman brand, the company offers sports and leisure footwear, apparel and accessories. It also sells footwear and apparel under the Converse, Chuck Taylor, All Star, One Star, Star Chevron and Jack Purcell brands. In addition, Nike offers sports equipment and accessories such as bags, balls, goggles, bats, gloves and other protective equipment.

The Company sells its products through various channels and outlets, including shoe stores, sporting goods stores, athletic specialty stores, department stores and its own Nike stores. It tops the list of the most recognizable and cost-effective brands in the world.

Founded as Blue Ribbon Sports in 1964, the company changed its name to Nike in 1971. It currently has a market capitalization of $143 billion.

Financial analysis

In late September, Nike released its fiscal first quarter 2023 results for the period ending August 31.

Sales increased by 10% at constant exchange rates, with strong direct sales at 14% growth at constant exchange rates. Digital sales of the Nike brand increased by 23%. Gross margins declined from 2.2% to 44.3%, as has been common in US companies recently, in this case due to high freight and logistics costs. Diluted earnings per share for the quarter were 93 cents, down 20% from the prior year period.

One of the stunning notes in the release was the comment on stocks, which rose 44% to $9.7 billion. This is due to high inventory in transit due to continued supply chain volatility.

Cash and cash equivalents and short-term investments were $11.9 billion, down approximately $1.8 billion from a year ago as free cash flow was offset through share buybacks and the payment of cash dividends. Total debt was $9.4 billion and operating lease obligations were $2.7 billion.

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The company generates significant free cash flow most years, ranging from $4 billion to $6 billion. Dividend payments totaled $480 million and share buybacks totaled $1 billion for the quarter. However, buying back so many shares with the company’s high valuation levels may not be the best use of company capital.

Evaluation

Analyst consensus estimates for earnings per share are $2.98 for the fiscal year ending May 2023 and $3.78 for the following year. Giving it the benefit of using next year’s more normalized earnings, Nike shares are trading at 23 times forward-looking earnings. The Forward Enterprise Value/Ebitda ratio is approximately 15. Management expects gross margins to decline between 2% and 2.50% in 2023.

The GuruFocus Discounted Cash Flow Calculator creates a value of $67, which is about 30% less than the current price. The inputs used were next year’s earnings per share estimate of $3.78 and a long-term growth rate of 10%.

The company pays an annualized dividend of $1.22, which creates a dividend yield of 1.35%.

Guru professions

Gurus who recently bought Nike shares include

Ken Fisher (Businesses, Portfolio),

George Soros (Businesses, Portfolio) and

Joel Greenblatt (Businesses, Portfolio), while

Mario Gabelli (Trades, Portfolio) reduced its stake.

Conclusion

With one of the most recognizable logos in the world, Nike is truly a global company with a dedicated fan base. However, margins and continued growth are both facing headwinds. Sales in China, a key part of overall growth, fell 13% last quarter. The excess inventory issue will continue to create operating margin headwinds for the foreseeable future.

The share’s excessively high valuation multiples do not currently create a margin of safety given the multiple global and operational risks the company is facing. A lower entry point for investors is likely warranted, perhaps with a price/earnings ratio in the mid-teen range.

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