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The Science of Hitting
The Science of Hitting
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Nike: Full Steam Ahead

An update on the leading athletic footwear and apparel company

September 27, 2019 | About:

Nike Inc. (NYSE:NKE) reported financial results for the first quarter of fiscal 2020 last week.

Revenue increased 7% to $10.7 billion, despite a strong headwind from foreign exchange (constant currency revenues increased by 10%). Growth was broad based, with each of the company’s international segments (Europe, Middle East and Africa, Greater China and Asia Pacific & Latin America) reporting double-digit constant currency growth; collectively, international grew 16%.

Digital revenue (e-commerce) increased 42% in the quarter, an acceleration from the 35% growth Nike reported in fiscal 2019. As noted on the call, sales through the Nike app nearly doubled year over year. In addition, SNKRS app revenues increased roughly 50% year over year, with run rate revenues likely approaching $1 billion (as CEO Mark Parker noted in his shareholder letter, SNKRS revenues and monthly active users more than doubled in 2019). As those numbers suggest, Nike has a lot of momentum in diigital. Chief Financial Officer Andy Campion stated on the call that: “Our targeted strategic investments are accelerating Nike’s digital transformation and extending our competitive advantage”. I completely agree; continued investment is expanding the company’s moat relative to smaller competitors like Under Armour (NYSE:UA).

From a geographic perspective, Nike benefited from another impressive quarter in Greater China, where constant currency revenue grew 27% to $1.7 billion (with digital up more than 70%). The segment has reported double-digit revenue growth in every quarter for the past five years. As shown below, the company’s China business is on pace for roughly $7.5 billion in revenues in 2020 – twice as high as they were four years ago (and a trailing ten-year revenue CAGR of roughly 16%).

It’s also worth noting that growth in China has a material impact on profitability: operating margins in Greater China were 40% in the first quarter – 1,400 basis points higher than what Nike reported in its North America business (and up 340 basis points year over year for the China business).

This is showing up in the consolidated results: for Nike as a whole, gross margins expanded 150 basis points in the quarter (to 45.7%), with gross profits up double digits. This reflect mix shift to international markets like China and digital – two trends that I expect to continue. With help from below the line items (a tailwind of roughly $90 million), pre-tax income increased more than 20%. The share count declined 2%, resulting in a 28% increase in earnings per share.

With the benefit of hindsight, we can see that Nike has delivered strong results since the financial crisis. Based on current estimates for fiscal 2020, the trailing 10-year compounded annual growth rate (CAGR) for diluted earnings per share (EPS) will be around 12%.

Conclusion

Driven by impressive results abroad and digital, Nike continues to knock the cover off the ball. But I think that reality is largely reflected in the stock price: at $92 per share, the stock trades at 30 times forward earnings. As shown below, the price-to-earnings multiple has expanded significantly.

Personally, I need assumptions that are too aggressive to justify buying the stock here. I'm just not comfortable assuming ~10% constant currency top-line growth and margin expansion in perpetuity. With that said, I would love to own Nike at the right price (if the stock fell 25% - 30%). Hopefully Mr. Market will be kind enough to give me a chance to do so.

Disclosure: None.

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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