Nike stock may seem expensive, but is it?

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Nike (NKE -0.24% ) Shares jumped on the back of its strong fiscal first-quarter earnings report last week. One of the highlights was the return to growth in footwear sales, following the decline in sales in the previous quarter. Even as stores reopened, customers continued to shop through Nike’s e-commerce channel, which boosted sales of classic sneaker styles.

As for the stock, it is trading at a forward P/E of 44, which seems expensive. Still, the valuation might be justified based on how much additional profit margin profit margin management can get from e-commerce sales in the future.

Image source: Getty Images.

Digital sales are very profitable for Nike

The quarter was strong overall, as Nike was operating below full strength with only the majority of its stores open. Nike is also expected to see its margins improve thanks to continued growth in digital sales, where the company generates 10 points higher gross margin than sales through the wholesale channel.

Digital sales accelerated sharply once shelter-in-place began in March, and it hasn’t stopped. Digital sales grew 82% year over year last quarter, which is slightly faster than the 75% growth in the previous quarter.

“Consumers’ accelerated transition to digital is here to stay,” CEO John Donahoe said on the fiscal first quarter conference call. Nike’s digital sales accounted for more than 30% of business last quarter. While the proportion of digital sales may decline as physical stores resume full speed, the e-commerce channel will become increasingly important to Nike’s future. Management expects digital sales to reach 50% business penetration over the long term.

Nike was aiming for an annualized profit growth rate before the pandemic, but it could grow profits faster in a post-COVID-19 world, based on Donahoe’s statement on the permanent shift to e-commerce and higher gross margin. high that these sales bring.

Nike backs it up with action. It is investing to expand its execution capacity and create predictive modeling tools to better anticipate demand. It also continues to push member personalization using data as more customers at checkout identify themselves as Nike members.

Footwear demand remains resilient

The high valuation is somewhat concerning as Nike is not a small, fast-growing player like its rival lululemon athletic. Nike is the world leader in sportswear, with a massive $37 billion in sales. Before the pandemic, its earnings had been growing at around 7.5% per year since 2013, which is not enough to sustain a high valuation.

However, the company’s profits grew faster than revenue, with net profit up 32% year-on-year in the quarter ended November last year. This trend continued in the last quarter, with total revenue down 1% but net income up 11%. Sneakers are in high demand, and with Nike’s demand creation spending down 33% last quarter, more profits have fallen to the bottom line.

“We tightly managed operating expenses, including lower and more effective marketing spend as live sporting events slowly began to pick up, while investing to support accelerating growth and transformation. digital,” Chief Financial Officer Matt Friend said on the conference call.

Friend explained some digital investments they’ve made recently, saying, “To date, we’ve done some impressive things to achieve scale, evidenced by our app ecosystem, RFID investment, and fulfillment centers. omnichannel.”

The stock is not expensive compared to growth expectations

Nike is technically a retail stock, but it becomes just as accurate to refer to it as an e-commerce stock. It is likely due to the dynamics of the digital sector that analysts currently expect earnings to grow at an annualized rate of 25% over the next five years, which is roughly in line with the level of earnings growth achieved before the pandemic.

Nike’s future in digital looks very bright, and continued e-commerce growth is a sure path to a higher profit margin. Prior to the pandemic, management was targeting annual gross margin improvement of 50 basis points, on average, per year through fiscal 2023, in part through its initiatives to connect directly with consumers. Recently, management announced its new Consumer Direct Acceleration strategy to further increase member engagement and personalization.

Based on the company’s momentum in e-commerce and the higher margins it is expected to achieve as digital penetration increases, Nike may not be as expensive as its lofty valuation suggests.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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