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Nike – Just Buy It

Nike just buy it
By: Bob Cramer
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Nike, Inc. (NKE) is the 30th most popular global brand according to the Global 500 2012 list released by Brand Directory. The company designs, develops and markets athletic footwear and apparel, sports equipment, accessories and services. Its major markets include North America, Western Europe, emerging markets and Greater China, which together contribute over 81% of Nike’s total revenues. North America alone contributes around 41% of Nike’s total revenues.

Nike beat analyst estimates for earnings for its most recent quarter. It announced diluted quarterly earnings of $0.86 per share for the first quarter (1Q) of fiscal year (FY) 2014, while analysts were expecting EPS of $0.78. Nike’s shares were up over 6.5% on the day following the announcement.

Nike’s exceptional performance can be attributed primarily to the growing success of its footwear brands. Converse, one of Nike’s most famous brands, saw revenues grow 16% due to higher sales in the UK, North America and China.

Accompanied by the success of other Nike brands – such as Hurley, Jordan and All Star – Nike’s growing footwear segment is the primary factor in the 39% year to date (YTD) increase in the company’s stock price. The hefty increase in stock price has recently raised concerns that the stock has reached its resistance levels; however, we believe that Nike can maintain momentum and continue to grow.

Key Drivers for Nike’s Future Growth

Rising Order Backlog:

Nike’s order backlog has shown steady growth since 2009, and has reached approximately $12.1 billion in the year ending May 2013. Future orders for NIKE branded products also increased by approximately 10% in the quarter ending August 2013. The growing order backlog reflects the company’s success in building its brands and innovating products, and supports the case for continued revenue growth in the future.

Rising Direct-to-Consumer Sales and Declining Raw Material Costs:

Nike’s gross margins decreased by approximately 208 basis points from FY11 to FY12, following a 23% increase in synthetic rubber prices, which is the primary raw material for footwear products. However, prices of synthetic rubber have been falling since 2012, and are expected to boost gross margins with increasing growth in direct-to-customer (DTC)* sales. (DTC sales refer to sales through company-controlled factory and retail outlets, and online sales.)

The prices of synthetic rubber declined approximately 13% in FY13, and DTC sales’ contribution to Nike’s total sales increased by approximately 2.2 percentage points during the same period. 

Nike’s gross margins grew by approximately 10 basis points in FY13, following the decrease in average raw material costs and an increase in DTC sales. DTC sales allow Nike to sell products at higher gross margins by bypassing wholesalers and appropriating their commission.

DTC sales have grown 20.4% annually over the last three years, and they remain a strong driver for Nike’s revenue growth in future. DTC sales are also expected to grow 15% annually over the next five years.

Given these trends, analysts estimate that Nike’s gross margins will expand by 100 basis points from 43.59% in FY13, to 44.59% in FY15.

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Expectations from Brazil:

Emerging markets (excluding China), which contributed 14.7% to Nike’s total revenues in FY13, remain strong growth drivers for Nike. Nike’s revenues from emerging markets grew 22.1% annually over the last three years, compared to the 10% annual growth in Nike’s total revenues over the same period.

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Brazil is one of the most important countries for Nike, and will be a key player in driving Nike’s future growth. Soccer is a highly popular sport in Brazil, and its national sports team is considered one of the best in the world. The country has traditionally been a big spender on sports and sports gear, especially soccer gear, and its growing economy signals a huge potential opportunity for Nike.

Brazil’s GDP growth rate increased from 0.1% in 2Q of calendar year (CY) 2012, to 1.5% in 2QCY13. Nike’s management believes the Brazilian market can grow as big as China’s, which currently generates $2.45 billion (9.68%) of Nike’s revenues.

Upcoming sporting events like the 2014 FIFA World Cup and the 2016 Rio Olympics in Brazil can lead to significant growth in Nike’s revenues from the country over the next three years.

Soccer is also the most popular sport in the world and the FIFA World Cup does not end with world cup matches: it lasts for nearly a year, as fans around the world spend heavily on premium athletic products in the days up to and following the event. Due to this reason, Nike’s sponsorship of the Brazilian and American soccer teams, along with partnerships with celebrity players like Brazil’s Neymar and Portugal’s Cristiano Ronaldo, will help boost Nike’s revenue growth not only in Brazil, but all over the world.

Brazil will also generate annual revenues of over $1 billion for Nike following the Rio Olympics in 2016. This will result in gross margin expansion as well, as most of Nike’s products sold in Brazil are produced within the country, which reduces transportation costs.

Growth in Basketball Footwear Categories:

Revenues from the basketball footwear segment currently contribute 24% of Nike’s athletic footwear revenues in the US. Revenues in this segment are growing at a higher rate, compared to other athletic footwear categories, such as ‘running’ and ‘casual’. The market share of basketball shoes in the US athletics footwear market increased by 2.9 percentage points last month compared to the same month a year ago.

The rising demand for basketball shoes in the US will benefit Nike the most, as its Jordan Brand alone accounts for 58% of the total US basketball footwear market. It has also signed sponsorship deals with famous basketball athletes such as LeBron James and Kevin Durant, which are likely to boost sales.

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Source: NDP Research, Sell side estimates

NIKE and Jordan Lead the Market:

Nike’s footwear segment contributes over 57% to its total revenues, and footwear brands like NIKE and Jordan account for around 59% of total footwear industry revenues in the US. The NIKE and Jordan brands gained 3.3 percentage points in market share last month over the previous year, while Adidas (ADDY) – Nike’s closest competitor – lost 0.6 percentage points in the same period. Furthermore, Adidas has a share of only 7.2% in the total revenues generated in the footwear market in the US, which shows that Nike’s products are a lot more successful and popular.

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Source: NDP, Sell side estimates

Beating Adidas in Sponsorship Deals:

Nike has also outmaneuvered its competitors in securing sponsorship deals. This year, it signed a sponsorship deal with the UK athletic team, which Adidas had sponsored since 2005. The deal will give Nike the opportunity to market its products via British track and field athletes in the 2017 World Championships in Athletics and increase its revenues in the UK.

Nike also signed a five-year sponsorship contract with the National Football League (NFL) in March 2012, which replaced a decade-old contract Reebok (which is owned by Adidas) had with the NFL. The contract, which is worth about $1.1 billion, allows Nike to market its apparel through all 32 NFL teams.

Valuation:

Nike is currently trading at a one-year forward price to earnings (P/E) multiple of 22x. This is higher than Adidas’ forward P/E multiple of 16x and Nike’s own 5yr average multiple of 18x, primarily due to the impressive quarterly results announced in 1QFY14. The average one-year forward P/E multiple of the key players in the US footwear industry is 21x.

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However, Costco’s P/E multiple using 2015 consensus EPS is 21x, equal to its historical 5 year average forward P/E. Costco traded at a P/E multiple of 22x even when its earnings growth declined in 2011.

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Conclusion:

Considering falling input costs and Nike’s strategic sponsorship deals for upcoming sports events, we see strong sales growth for the company over the next three years.

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Furthermore, analysts forecast that Nike’s earnings will grow by approximately 14.8% annually over the next three years, better than the 11.7% annual increase over the last three years. With its strong growth prospects, Nike is a good investment option. Go ahead: Just buy it!

*Compound Annual Growth Rate

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