Shares of Nike Inc. (NKE, Financial) have risen about 20% since the company's earnings report was released in late September. Shares were previously moving in a continuous downtrend with a low of $88.66, marking the 11-month low in the stock.
However, better-than-feared earnings sent Nike shares rallying as bears used this event as an opportunity to close shorts while short-term traders saw an opportunity to capitalize on the oversold conditions.
Following the recent recovery, Nike shares are now down around 11.5% in 2023, still vastly underperforming the S&P 500. On Wednesday, the stock closed at $103.54. Its current market capitalization stands at just over $160 billion.
Company overview
Nike is a globally recognized leader in the sportswear and athletic footwear industry. The company designs, develops and markets a wide range of athletic apparel, footwear and equipment for various sports and fitness activities. Its revenue comes from the sale of its products through various distribution channels, including retail stores and e-commerce.
The company has established a strong brand presence worldwide, making it a dominant player in the market. With a solid presence in international markets, Nike's iconic "swoosh" logo is synonymous with quality, innovation and performance. The company's commitment to innovation is evident through its cutting-edge technologies such as Nike Air and Dri-FIT.
The company's international exposure is a significant contributor to its success. It operates in numerous countries, selling its products through a vast network of retail stores, authorized retailers and a robust e-commerce platform. Besides North America and Europe, Nike is also very popular in China.
Fundamental analysis
The ownership of Nike shares offers investors a great chance to have strong exposure to a company with a very robust fundamental profile. Nike stands as one of the most robust consumer brands worldwide, offering continuous prospects for sales growth, improved profit margins and the generation of free cash flow.
For this reason, many analysts argue Nike deserves a premium valuation, mainly due to the sustained potential for revenue expansion, margin enhancement and free cash flow generation.
According to the GF Value Line, Nike's shares are significantly undervalued, therefore offering an attractive opportunity.
Nike's current price-earnings ratio of 31.95 is just above the historical average of 31 and higher than global peers, which is understandable given its exceptional business, leading position in an attractive market segment, margin-enhancing strategies and a robust balance sheet. The median price-earnings ratio stands at 30.18.
According to GuruFocus, Nike's return on invested capital– a measure that tracks how well a company generates cash flow relative to the capital it has invested in its business – stands at 22.16%.
Over the past 12 months, its average earnings per share without non-recurring items has shown a growth rate of -8.20% per year. For the past three years, however, the average earnings per share without NRI growth rate was 26.40% per year. Looking back over the past five years, the average growth rate for the same metric was 22.50% per year. Over a 10-year period, the average earnings per share without NRI growth rate stood at 9% per year.
Given that Nike generates a significant portion of revenue outside of the U.S., the company felt strong foreign exchange headwinds in recent quarters. More precisely, gross margins declined by about 300 basis points in the last quarter due to a stronger dollar, as well as due to higher promotions.
The company's revenue for fiscal year 2022 was $46.71 billion, reflecting a 4.9% increase from 2021 when it reported revenue of $44.54 billion. This marked a significant 19.1% increase from the revenue in 2020, which was impacted by the Covid-19 outbreak.
Nike reported full-year revenue of $51.2 billion for fiscal 2023, which ended May 31. Current Wall Street estimates see this number falling to $50.1 billion for 2024, before expanding to $53.9 billion in 2025, which would indicate growth of 7.6%.
According to GuruFocus, over the past 12 months, Nike's average revenue per share growth rate was 12.10% per year, which compares to 11.6% for the last three years and 8% during the past five years. The total revenue growth rate over the next three to five years is estimated at 6.5%, which indicates growth deceleration compared to recent years. The earnings per share growth rate is projected to be 13.5%.
Top holders
The Vanguard Group is the largest shareholder with a stake of 8.53%. It is followed by Philip Knight (3.09%), Geode Capital (1.7%), Capital Research (1.09%), and Fidelity (1.02%). Other notable investors include Norges Bank Investment, Wells Fargo, Fundsmith and Janus Henderson.
Competition
Nike competes with several major companies and brands in the athletic and sportswear industry, including Adidas (ADDYY, Financial), Puma (XTER:PUM, Financial), Under Armour (UAA, Financial), Reebok, New Balance, Lululemon Athletica (LULU, Financial), Asics (ASCCF, Financial), Skechers (SKX, Financial), Peach John and various local and niche sportswear brands.
Adidas, with a market capitalization of 30 billion euros, is Nike's greatest rival. These two companies are the most prominent and fierce competitors in the sportswear and athletic footwear industry. In 2022, Statista said Nike generated 42.65 billion euros in revenue, while Adidas made 22.51 billion. Puma, another major player in this sector, generated 8.47 billion euros.
The company has faced stiff competition in recent years in China. Local players, like Li-Ning and Anta, experienced robust quarterly sales growth of 15% or more. In contrast, Nike's Greater China sales growth has been negative, with declines of up to 24% during the second quarter of 2022, which ended on Nov. 30, 2021.
More recently, China has been one of the key drivers of the selloff in Nike. It is at the center of Nike's bear thesis. Consumer data indicators in China start to show signs of decline and deceleration in demand. Most recently, although Nike's brand performance had been strong in the April to June period, there has been a notable slowdown in demand during July and August.
Why is China that important? While Nike's core consumer base in North America stands at 50 million people, the projected consumer base in China over the next few years could potentially be 10 times that number. The company derives about 20% of its global revenue from China, making it the brand with the most extensive market presence in the region.
On the other hand, the North American market appears to be the most resilient market for Nike as U.S. consumers continue to defy the logic of higher interest rates weighing on spending habits.
Can Nike extend its rebound?
Revenue growth deceleration is likely a direct result of China headwinds, swollen inventory levels as well as a tough macroeconomic environment that is pressuring demand for apparel products. In case Nike can accelerate top-line recovery and continue to grow its revenue in double digits going forward, the stock is very likely to re-rate higher.
I am optimistic that a combination of downbeat investor sentiment and solid underlying trends should position Nike stock for a continued recovery. Remember, the company maintained its full-year guidance in September despite headwinds in China.
Most importantly, Nike is still expanding its margins and expects the gross margin for the second fiscal quarter to grow by 1 percentage point. For the full year, the company expects gross margin expansion of 1.4 to 1.6 percentage points.
Margins are one of the key focuses for investors as they are looking at swollen inventories and high promotions. Continued progress on this front could help the stock rebound to extend. Nike's next earnings report in December could act as a catalyst.
Technically, while the rebound stalled at 38.2% Fibonacci retracement of the February to September drop, improving fundamentals could help shares to extend the rebound to at least 50% retracement level, signaling an upside potential of about 10% from current levels.
Conclusion
Investors are likely to remain laser-focused on China and margin expansion as they await signs of top-line stabilization. China, being the most profitable region for the brand, continues to be a pivotal driver of growth, especially as the region recovers from the challenges posed by the Covid-19 pandemic.
As China's growth deceleration is hurting Nike and its stock, the stabilization in this region could also help it to recover and return to trade in the green territory on a year-to-date basis. The faster-than-expected recovery in China and continued gross margin expansion are likely the two drivers that should support Nike's valuation in 2024 and beyond.
