In June 2022, we published an article on NIKE, Inc. (NYSE: NKE) titled Don’t Buy Nike Yet, outlining the key pros and cons of investing in Nike stock. At that time, we valued Nike’s stock as a take”. We viewed the company’s execution of its Consumer Direct Acceleration strategy and its commitment to return value to its shareholders as favorable, while we assessed our concerns regarding the elevated valuation and macro headwinds, including lower consumer confidence, rising commodity prices and geopolitical tension in the Eastern European region.
In this article, we’ll revisit Nike’s stock and provide an updated view by highlighting the two main reasons why we still think Nike’s stock should be avoided.
1.) Macroeconomic uncertainty remains
On the one hand, the macroeconomic environment has not improved radically.
- Although oil prices have declined since our last article in June, they still remain at significantly higher levels than in 2021. The recent production reduction initiated by OPEC+, could lead to a further rise in oil prices.
- US consumer confidence has improved somewhat but still remains at extremely low levels.
- Inflation in the United States and Europe remains high. Soaring energy prices in Europe, fueled by uncertainty about Russian gas supplycause significant concern before the winter months.
- China has imposed new closures due to the Covid-19 outbreaks across the country. This may result in reduced demand for Nike products as well as potential supply chain disruptions.
We believe these recent global developments are not creating a favorable environment for consumer discretionary companies, including Nike.
On the other hand, Nike’s decision to exit the Russian market somewhat reduces the uncertainty associated with the company’s future operations and potentially helps investors better assess the company’s financial performance in the near future.
The economic sanctions imposed on Russia during the fourth quarter of fiscal 2022 impacted our local operations and a reduction in ruble liquidity affected our ability to manage the operational impact and related currency risk. Accordingly, we deconsolidated our Russian legal entities, whose net revenues represented less than 1% of consolidated net revenues for fiscal year 2021. The deconsolidation of our Russian legal entities resulted in a one-time pre-tax charge of $96 million. recognized in Other (income) expenses, net, classified in Corporate. After the end of the 2022 financial year, we made the decision to exit the Russian market.
With the Russian business accounting for less than one percent of consolidated net sales, we believe this decision is unlikely to have a material direct impact on business performance.
2.) Strong USD creates new headwinds for the business
Nike has a large presence outside of the United States. According to the annual report released in July 2022, the company had a total of 344 retail stores in the United States, while it had more than 700 stores outside the United States.
The following graph and table show that the international segment is not only larger in terms of the number of stores, but also in terms of revenue.
Nike reports its foreign exchange gains and losses in the “Corporate” segment.
Business revenue primarily consists of currency hedging gains and losses related to revenue generated by entities within the NIKE brand and Converse geographic operating segments, but managed through our central management program currency risk.
Corporate’s loss before interest and taxes consists primarily of unallocated general and administrative expenses, including expenses associated with centrally managed services; depreciation and amortization related to our corporate office; insurance, employee benefits and undistributed compensation programs, including stock-based compensation; and certain exchange gains and losses.
In addition to foreign exchange gains and losses recognized in Corporate revenue, Corporate foreign currency results include gains and losses resulting from the difference between actual exchange rates and the standard rates used to record purchases of denominated products. in non-functional currencies within the NIKE brand. geographic operating segments and Converse; the results of related currency hedging; translation gains and losses resulting from the revaluation of monetary assets and liabilities in non-functional currencies; and certain other foreign currency derivative instruments.
Although losses decreased by $42 million in fiscal 2022, they are mainly attributable to the favorable variation in net foreign exchange gains and losses of $219 million related to the revaluation of monetary assets and liabilities denominated in non-functional currencies and the impact of certain currency derivatives, presented as a component of consolidated other (income) expenses, net. On the other hand, a $190 million unfavorable change related to the difference between actual exchange rates and standard exchange rates attributed to the NIKE brand geographic operating segments and Converse, net of hedging gains and losses, has been declared.
In the Economic and Industry Risks section of the annual report, Nike also highlights the risk associated with foreign currency transactions:
We transact in various currencies, which creates exposure to fluctuations in exchange rates against the US dollar. Continued volatility in foreign currency markets and exchange rates and foreign currency contracts could materially affect our reported results of operations and financial condition.
In our view, despite Nike’s hedging strategy, currency headwinds are likely to persist as long as the US Dollar remains at current levels against foreign currencies.
Key points to remember
As the price of Nike, since our last article, has even increased, while the fundamentals and the macroeconomic environment have not improved drastically, we believe that at the current valuation, the share of Nike is still overvalued.
What we pointed out in June about the valuation of the company still applies:
Nike’s price-to-earnings ratio (FWD) is around 32x, more than double the consumer discretionary median of around 12.5x. The company’s EV/EBITDA and P/CF also show a similar trend and indicate that Nike is trading at a significant premium to its peers.
We understand that Nike is a growing company and its strategic shift to direct-to-consumer sales can lead to increased margins; however, we believe that such a large premium is not justified.
For these reasons, we are maintaining our hold rating on Nike shares.