Do it, buy some Nike stock? Not at this price (NYSE:NKE)

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Nike (NYSE: NKE) is an interesting company from an investment point of view. After gaining 33% this year, the analyst community is divided on Nike’s next direction. The authors of Seeking Alpha are neutral on the company, but Wall Street analysts are split 17/3 between “buy” and “hold”. In today’s article, we’re going to explore this clothing giant and see if there’s outsized return potential.

A massive moat of discretionary consumption

I just looked down and I’m wearing something made by Nike. Our shoe rack at home is probably 1/3 of Nike too. If you watch sports, you see Nike. If you go out to the store, a good portion of the people you come across will be wearing Nikes. The brand is everywhere.

Nike’s signature swoosh has infiltrated almost every aspect of life and is recognizable across the globe. Nike does not sell the best quality products, but over the years it has positioned itself in a perfect place, catering to most of the world’s population.

The gap that Nike has built is seemingly insurmountable. Adidas is perhaps the only company to come close to around three-quarters the size of Nike in terms of revenue.

This gap allows Nike to do something that will essentially redefine the company over the next decade, going direct to consumer. It’s not a new change, it’s one that’s been in the works for some time, but by going direct to the consumer, Nike can fatten its margins and continue its global dominance.

Growth catalysts

With a company the size and stature of Nike, there are usually very few catalysts that could trigger outsized growth. Usually just keep running and take the option when it comes. For Nike, there are plenty of options and many areas where this quarter-trillion-dollar behemoth could find some growth in the future.

A digital shift

I mentioned it above, and anyone who’s read _literally_ anything else about Nike is familiar, so I won’t repeat it too much, but a digital shift is underway.

Nike just ended its 2021 fiscal year with record revenues of $44.5 billion, a 19% gain over the previous year. Nike Direct, the company’s direct-to-consumer arm, grew 32%, driven by 60% digital growth.

Wholesale Nike versus Direct Sales

Chart: Breakdown of Nike Wholesale vs. Direct Sales – Author’s Chart – Data by Nike 10K

The graph above shows the breakdown of sales for the past three years for Nike. Nike Direct, where this digital shift is happening, is seeing decent year-over-year growth. In 2019 growth was only 5%, but 2020 saw this acceleration to 30% and then further growth of 32% in 2021. Although still not the strongest branch important part of the company, it is clear that Nike strives to go directly to customers. while wholesale trade has remained largely stable over the past three years.

A growing global audience

NIKE is a truly global brand and you only have to look at a breakdown of company revenue to see that.

Nike's worldwide revenue

Chart: Nike Global Revenue Breakdown – Author’s Chart – By The Nike 10K

All four geographic locations experienced growth over the past fiscal year. Greater China leads the pack with 24% growth while North America shows 19% growth on an already massive base of $14.48 billion.

According to the company’s 10K filing, management expects the company to be able to sustain low double-digit revenue growth through 2025. Should the company achieve this, EMEA, the Asia-Pacific and Latin America would be the main markets to target. China, which we will come to, may be a little difficult in the years to come.

Dare I say… The Metaverse

It’s the buzzword to end all buzzwords, but there’s definitely potential here for one of the world’s most recognizable brands.

For investors and for the company, the metaverse represents optionality. A near zero cost option. Nike has spent decades building its brand, it can now generate digital revenue on that brand with very little upfront cost.

Exclusive shoes in Roblox (RBLX)? NFT of the latest Jordan sneakers? Clothes to wear in the next big VR experience? All of this would cost little to implement, but could be worth millions in revenue.

While it’s impossible to say how much the Metaverse and NFTs might be worth, it’s worth noting that people are paying hundreds of thousands of dollars for “Bored Apes” NFT ownership.

Oh, and I’m not spitting on Nike’s ambitions in this area either. The company has already patented “CryptoKicks”, which would allow users to assemble virtual shoes to create unique iterations. The company has also filed seven other virtual goods patents that were covered by Fortune earlier this month.

Again, nothing concrete yet, but we know Nike will enter this space. We also know that Nike is a powerful brand that will command attention and, if things like Bored Apes are anything to go by, there’s a lot of money floating around in the digital realm.

Incredibly run business

One of my criteria for buying a business is that it must be perfectly managed – or – of high quality. Nike is a high quality company and has an outstanding track record.

In terms of what could be a period of wild inflation, I think the best place for our money is in high quality earning assets. A company like Nike would be able to weather the storms of a high inflation environment while smaller competitors might suffer.

I’m not saying that Nike would come through tough times completely unscathed, but if I had a choice between holding cash or owning a high-quality company like Nike, I choose Nike every time.

What makes Nike a great company? Simple, it has high returns on equity, high returns on invested capital, limited debt, it does not dilute (long term) shareholders, it has a track record of growth and excellent margins.

Nike Gross Profit Margin
Data by YCharts

On the margin front, let’s look at the company’s gross margins. As you can see, Nike regularly posts gross margins north of 43%. Granted, they wobble a bit, but that consistency is golden. According to the company’s latest 10K filinginvestors should also expect some growth in this metric – Nike is aiming for the “high 40s”.

Nike ROIC
Data by YCharts

Also in this 10K Ranking, Nike is committed to achieving and exceeding a 30% return on investment. I’ve put a five year chart above to demonstrate that it’s achievable, Nike has already reported an ROIC above 30% in the past, and the company has come close to doing so over the past two quarters either. I tend to look for companies with an ROI of 12%, so 30% would be great.

There were also a lot more pledges than we expected to see from high quality companies. Of course, a commitment is no guarantee of success, but it’s great to be able to see what management is aiming for. Here is the list :

  • High-single-digit to low-double-digit revenue growth
  • EBIT margin in the 1980s
  • Average to High Teen BPA Growth
  • Annual capex at 3% of turnover

Can Nike really achieve all of this in the next four years? Absolutely. The company is either reaching or close to reaching all of them today.

Let’s talk evaluation

On a discounted cash flow basis, Nike is fairly well valued. To counter that, it’s a high-growth company with plenty of options in the future.

Nike DCF Valuation

Image: A DCF evaluation of Nike – Author’s screenshot

Above is a preview of my model. In this model, I gave Nike a CAGR of 10% for the top line. This is in line with the company’s own estimates and is well based on historical performance. The assumption is also made that Nike can increase its free cash flow margin to 15% through digital transformation (it was 13% last year).

From there, we scale things down to 8%, which is fair for a company of Nike’s stature, and we grow the company by 3% in perpetuity. This gives us a fair value of the company at $195 billion, or $124 per share. Given that Nike is trading 36% higher than at the time of writing, it becomes rather difficult to recommend the stock on this basis.

Even looking for potential tweaks to the model that would bring us to a fair value of $168, I run into a brick wall. The closest we can get is to assume that Nike can increase FCF margins to 20%, which would certainly be an overstatement.

How about assuming that the metaverse and NFTs can add $4 billion in additional revenue by 2026 and grow the business by 4% in perpetuity? Even then, we get $157 per share as fair value today.

I’d be okay with a company like Nike carrying a premium as an iconic brand, but I can’t see myself buying when the math just doesn’t work. However, I don’t believe a buyer today would completely regret their decision five years from now, but I don’t see them outperforming the market at these levels.

Risks

Stock price today is absolutely the biggest risk an investor faces, especially in the face of macroeconomic concerns.

Nike is competing in a turbulent market with an exceptionally high valuation. The company has a price-to-earnings ratio of around 45, a price-to-sales ratio of 5.9, a price-to-book ratio of 18.7, and a price-to-FCF ratio of 44.11. With the exception of a few bad years in terms of EPS, these numbers are all well outside their upper-side bounds and show that investors expect a lot from Nike.

Plenty at a time when Nike may struggle to deliver through no fault of their own. Many at a time when Nike is transforming the business. Many at the same time Nike faces an onslaught of local competition in Chinaa key market for the future.

However, the share price could be influenced by this macroeconomic fear. Where else are you supposed to put your money to work? Do you let it earn 0.05% in a savings account when inflation is north of 5%? Absolutely not. Do you put it to work in established global companies that might be able to weather the storm? I do, and it’s a very valid reason to buy Nike today.

Final Thoughts

Nike has huge potential and lots of options in the future. There are reasons to buy Nike today and keep it for the long term, those reasons just don’t sit well with me today, which is why I’ll join the Seeking Alpha crowd in being “neutral” on this name.

When will I buy? If Nike were to see another dip into the $140s, I’d take another serious look. As I mentioned, I think Nike has a premium as an iconic brand, and that premium would make me a happy buyer in that $140 range.

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