- North America sales decline 5% year on year – why?
- Gross margins are coming down despite ‘brand premium’
- At ~24x forward earnings – it’s not yet cheap
NIKE is one of a handful of companies I consider ‘bellwether’ stocks.
For example, JP Morgan, FedEx, American Express, Visa, Costco and Apple also fit this bill (among others).
Quarterly reports from these companies (and guidance) often give us a good ‘pulse’ on both the consumer and economy.
With respect to NIKE – not only do they tell us what’s going on with consumer discretionary spend – we also get great visibility into the impacts of things such as inflation, supply chain and currency strength.
For example, with respect to discretionary spend, if you have a spare US$200… why not shell out for the latest pair of Air Jordans or a Tiger Woods shirt.
Right?
However, if the purse strings are a little tighter due to costs such as higher rent, fuel and food – maybe the Air Jordans might be on hold?
Just saying.
Today NIKE announced their latest quarterly earnings… and it was a mixed picture.
Some good. Some bad. Some confusing.
I will get to the numbers shortly – but let’s frame the missive with the weekly chart.
Investors have been bailing on the “swoosh” for almost a year… and with good reason.
NIKE: ‘Just Dump It’
Approximately one month before Jay Powell pivoted on his “transitory” inflation narrative November of 2021 – NIKE shares traded at almost $180.
Since then, it’s been a train wreck.
Follow its quarterly earnings today – the stock trades for just $102 and likely headed lower.
Question is – how much lower?
June 28 2022
I will get to the fundamentals in a moment (as the stock still isn’t cheap) — but first the technical set up.
- First, the stock entered a bearish weekly trend in January 2022 – at a price of around $150 (around 16% off its all-time high). At that point, the expectation was for lower prices.
- Second, in September 2021, the stock made a “higher low” at $148. However, when the stock broke below that low in January – there was a high probability it was headed down.
- Now over the past 10 years, we can see the rising trend line – formed by a series of higher lows. The bottom range of this trend channel is around $80. The upper end of this channel is around $100 (where we are today).
- From mine, I think we’re likely to see NIKE trade back inside this channel over the coming few quarters. For more conservative traders, I would wait for NIKE to put in a new higher low before entering.
But let’s now turn to the fundamentals and the latest earnings report… it was a mixed bag.
NIKE’s Fundamentals
Despite a horrendous 9 months – NIKE has been a winning stock to own – meaningfully outperforming the market (despite the recent 43% correction)
For example, the stock traded around $40 in June 2014 – which realized a CAGR of 12.4% plus the approx 1% dividend (i.e., total CAGR of ~13.4%)
If we compare that to the S&P 500 over the same 8-year timeframe – it has a CAGR of 8.53% (exclusive of a ~2% dividend for a total CAGR of ~10.5%).
At the time of writing, NIKE trades based on the following (widely cited) ratios:
- Forward PE of 24.2x
- Free Cash Flow Yield of 3.7%
- Price to sales of 3.8x
- PEG ratio 1.8x (where growth was expected to ~13%)
Going into the print — analysts were yet to revise their estimates lower.
Not now…
11 analysts have quickly slashed their expectations for NIKE’s growth and gross margins (more color on this below)
This is what we learned today:
- EPS: $0.90 vs $0.80 expected
- Revenue: $12.23B vs $12.06B expected
- Gross Margin: 45% vs 46.6% expected
And by region:
- North America: $5.12B Down 5%
- EMEA: $3.25B Up 9%
- Greater China: $1.56B Down 19%
- APAC + LATAM: $1.68B Up 15%
With respect to the “EPS beat” of $0.10 — ignore that — as most of this was due to a favourable tax item.
However, the reason for the 7% smack-down today was arguably three-fold:
- Deterioration in gross margin (i.e. what they make after the cost of goods sold);
- 5% lower year-on-year sales for North America; and
- Low double-digit growth guidance on a constant currency basis
Gross Margins:
This is a troubling trend for the stock.
For example, in this case, some is attributable to what they are feeling with China (as NIKE said gross margin would have been 100 bps higher if it were not for COVID lockdowns); and some of it is inflation in terms of logistics costs.
But given NIKE’s iconic brand – investors expected they had greater pricing power.
Nope.
What’s more, with their 2-year push into the Direct to Consumer (DTC) business (e.g. dumping big retailers like Amazon and Footlocker) – that was also expected to offset some of the higher costs.
Nope.
Investors will be hoping to see this trend reverse in coming quarters however the CEO said otherwise. They advised that gross margins will be flat to down 50 basis points – as higher costs continue to bite.
Sales Growth
With respect to sales – for me – NIKE is still very much a North America + Europe story. These two regions represent $8.37B (or 72% of all sales). And whilst China is said to be growing… it’s still all about North America.
NIKE said that 60% of its Chinese sales ($1.56B – down 19%) was disrupted by COVID lockdowns in more than 100 cities. And that’s understandable… expect these to come back in 2023.
Now, the international numbers would have been better if it were not for continued US dollar strength.
However, this is a headwind we’re seeing from most global companies (e.g., Microsoft and Salesforce recently) – who are citing the offset from dollar strength on international revenues.
Expect this trend to continue as the Fed Reserve continues to hike interest rates.
However, when North America is down 5% year-on-year – that cannot be blamed on “dollar strength”.
My read: this is the US consumer tapping out.
Forward Guidance
This was where the rubber met the road today and why the stock was dumped.
They now forecast low double-digit revenue growth for the fiscal 2023 year (~10% vs ~13% expected) but only on a constant currency basis.
In other words, if the US dollar remains strong (or gets stronger) – this could fall to the high single digits.
Now if NIKE is to only post “high single digit” growth next year – it’s difficult to justify a 24x forward PE; and/or a PEG ratio of 1.8x.
And that’s why I think we temper our expectations…
Just Do It?
Nope… not just yet.
When I look at the (longer-term) technical chart and fundamentals — you can start looking at NIKE in the zone of $80 to $90 per share.
The days of NIKE trading for a forward PE of 40x are well and truly done.
The Fed put a swift end to that nonsense.
That said, NIKE is a strong business and I’m sure over the longer-term — it will navigate headwinds such as inflation, supply-chain, US dollar strength, and a generally weaker consumer.
But this is going to take time (as the CEO said in the earnings call).
In the near-term, the stock is going to come under a lot of pressure (especially with current quarter guidance very weak)
Putting it All Together
Add NIKE to the growing list of names where analysts are rapidly revising down their expectations.
As I’ve been saying in recent missives – this is a trend we will see over earnings season.
Analysts are always late to the party — where the “E” in “PE” needs to come down… and it is.
As an aside, paying 24x forward earnings for a company likely to only grow “high single digits” (given expected currency headwinds) – that’s a hefty premium.
And whilst I recognize it deserves ‘some’ premium (e.g., given the strength of its brand and business) – for me that is 20x forward at most.
For example, based on full year EPS of around $4.25… that would be in the realm of $85
Looking at the chart – I think that’s where we will see good support – and where you can add to the name for a reasonable (longer-term) risk / reward.