Is Nike’s Sports Supremacy Enough to Justify Its High Valuation? – ValueWalk Premium
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Is Nike’s Sports Supremacy Enough to Justify Its High Valuation?

The post was originally published here.

Highlights:

  • Digital expansion bears fruit, driving top-line growth
  • Reengineering retail business could enhance margin further
  • Competitive position means profits beat those of biggest rival

Q1 2022 hedge fund letters, conferences and more

Download the full report as a PDF

Nike’s revenue breakdown 2021

Price turned bearish

  • The share price has shown strong volatility over the past few months
    • Most recently, the 50 DMA has fallen below the 200 DMA, which could be the start of a bearish trend
  • Volume RSI is still slightly above the 50%-line, but not providing a clear signal yet

Digital expansion bears fruit, driving top-line growth

  • Digital sales already make up around 25% of Nike’s revenue in 2021 compared to 5% in 2014
  • Compared to its competitors, Nike already expanded early in its digital channels, which delivered high growth
    • Especially during the pandemic, its early efforts paid off big
    • The new normal could continue to push digital sales further up

Digital penetration is part of its strategy shift

  • The company increasingly focuses on direct-to-customer sales
    • Under its campaign “Nike Direct” it aims to promote its own retail stores and expand its online platform
  • The objective is to create a monobrand experience and reduce the reliance on wholesalers
    • As a result, Nike can yield a higher average selling price

How I incorporated the story into my forecast

  • Expanding digital sales comprises the key growth driver in the future

Reengineering retail business could enhance margin further

  • In 2021, Nike’s direct sales make up 35% of total revenue compared to 26% in 2017
  • By 25E, the company aims to ramp up the contribution of direct sales to 50%, cutting out wholesalers
    • Wholesale partners tend to offer large discounts when reselling, devaluing the brand
    • The shift also enables Nike to regain price control of its products

Cutting out the middleman  should result in margin expansion

  • Focusing on direct sales could enhance Nike’s gross margin by 2ppts over the near-term future, with further potential over the long run
  • In my opinion, this strategy makes sense as the company, unlike in its initial growth stage, is no further dependent on wholesalers to raise brand awareness

How I incorporated the story into my forecast

  • Scarcity creates demand; Nike continues to reduce its own retail stores making their products more desirable
  • The increasing management’s efforts to shift to direct sales should be rewarded with a significant gross margin expansion

Competitive position means profits beat those of biggest rival

  • Nike’s 5-yr revenue 6.8% CAGR was 4x higher than 2nd largest sports giant Adidas
  • ROE of 37% at Nike clearly beat 21% at Adidas, while ROIC was 2x larger than Adidas
  • Nike’s profit is remarkably high, of course the risk is that it can only fall from here
    • Meanwhile, Adidas has room to improve

What is the role of cash in invested capital?

Massive value creation is already priced in

  • In 2021, Nike delivered an astonishing ROIC of 69% and could maintain the heightened level over the short run
    • I forecast that Nike can grow its extreme level of ROIC over time as it generates a lot of cash
    • Still, it does not lead to any upside which makes me assume that the consensus is too bullish about Nike’s growth prospects

How I incorporated the story into my forecast

FVMR Scorecard – Nike

  • A stock’s attractiveness relative to stocks in that country or region
  • Attractiveness is based on four elements
    • Fundamentals, Valuation, Momentum, and Risk (FVMR)
  • Scale from 1 (Best) to 10 (Worst)

Consensus is strongly bullish

  • Most analysts have a BUY recommendation, while 2 analysts issued a SELL
  • Consensus is rewarding management’s efforts to focus on direct-to-customer sales
    • They forecast a gross margin expansion of 3 ppts over the next 3 years, which might be a bit too optimistic

Get financial statements and assumptions in the full report

P&L – Nike

  • Net profit is driven by both continued revenue growth and gross margin expansion

Balance sheet – Nike

  • Defensive balance sheet with 1/3 of its assets in cash
    • As CAPEX requirements are moderate, the company might decide to return part of its cash in form of share repurchases at some point in the future
  • Balance sheet size is almost 2x bigger than its rival Adidas

Ratios – Nike

  • Thanks to its margin expansion, Nike could see its EPS grow faster than its revenue
  • Nike’s gross margin is below its competitor Adidas which averaged 49% over the past 5 years

Stock Picking Checklist: Can this company be a ten bagger?

Free cash flow – Nike

  • CAPEX requirements are low, leading to high sustainable FCFF

Value estimate – Nike

  • I expect lower revenue growth than consensus but higher net margin, leading to similar earnings forecast
  • With a 4% terminal growth rate, I am already on the optimistic side
    • Also, I assume the company to maintain its massive ROIC over time

World Class Benchmarking Scorecard – Nike

  • Identifies a company’s competitive position relative to global peers
  • Combined, composite rank of profitability and growth, called “Profitable Growth”
  • Scale from 1 (Best) to 10 (Worst)

Key risk is intense competition

  • Entrance of new players joining the fitness and sports market with niche products
  • Failure to meet local customer requirements, in particular emerging markets
  • Consolidation of retail shops might impair ability to sell

Conclusions

  • Direct-to-customer selling approach raises brand value and could enhance margin
  • Early digital expansion gives it timing advantage over competitors
  • Valuation is not cheap, bullish rally probably over

Download the full report as a PDF

Article by Andrew Stotz, Become a Better Investor.


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