Nike Stock: More pain ahead in the near term (NYSE: NKE)

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Joe Raedle

Investment thesis

Nike (NYSE: NKE) released its results recently and while the numbers weren’t great, they were still pleasantly surprising, especially in China where everyone expected the company to suffer badly. In this article, I argue that despite the resilience shown by business through a tough quarter, macroeconomic headwinds are likely to outweigh this resilience in the months ahead. That said, from a valuation perspective, the stock appears to be undervalued, especially after the recent strong sell-off.

Nike Digital continues to perform even in a challenging macro environment

One of the few bright spots in Nike’s fourth quarter results was growth in its direct-to-consumer segment, Nike Direct. Revenue in this segment jumped 7% YoY and 11% YoY on a currency-neutral basis. This jump can be attributed to the surge in its digital business, Nike Digital, which continued its impressive growth. Fourth-quarter Nike Digital revenue grew 18% year-over-year and the segment now represents 24% of the brand’s total revenue. Nike Digital also saw sales grow in the mid-single digits in China despite the country’s strict lockdown measures, underscoring its strategic importance to the company.

Nike Direct in general, and Nike Digital in particular, are expected to continue to grow as the company plans to revamp its enterprise resource planning (ERP) system as part of its direct-to-consumer acceleration strategy. The new ERP system is expected to go live in China later this month and is expected to be deployed in FY24 in North America. ERP tools are loaded with tracking and management of inventory, purchasing, supply chain and other essential business operations. The fact that Nike is redesigning its ERP therefore demonstrates the importance the company places on its DTC segment, and rightly so.

According to Statista, global retail e-commerce sales are expected to grow from $4.93 trillion in 2021 to approximately $7.4 trillion by 2025, translating to more than 50% growth over the next four years. Nike Digital should therefore remain a catalyst for long-term growth.

Nike’s other digital initiative involving the Metaverse also showed progress over the past quarter. With the help of RTFKT, the digital fashion company that Nike acquired last year, the company launched its first NFT sneakers, the Nike Cryptokicks, inspired by the Nike Dunk sneakers. The sneakers, which cost between $6,000 and $10,000is the company’s digital bet to pursue its Metaverse ambitions.

Although the Metaverse is far from mainstream, it should be the next major battleground for retail. According Market data center, the retail market in the Metaverse is expected to be valued at over $125.7 billion by 2030, representing a CAGR of approximately 36%. Early steps taken by Nike, such as the Cryptokicks, position the company well to capitalize on this lucrative opportunity in the years to come.

Macro Headwinds to Test Nike’s Resilience: The Risks Ahead

While Nike showed resilience in the fourth quarter despite the multitude of headwinds it faced, continuing to rely on its resilience in the coming quarters might be asking too much. There are many landmines, defined by the current macro environment, that the business must navigate.

For starters, transit times have remained elevated from pre-pandemic levels and are expected to remain elevated in FY23, which could lead to higher shipping costs and an increased likelihood of obsolete inventory. Management has previously indicated that the company is facing a 100 basis point headwind in the first quarter on the back of high ocean freight costs and higher product costs. Gross margin pressure is expected to exceed 100 basis points, management says, due to the late arrival of inventory, which subsequently forces the company to spend more on promotional activities to eliminate now obsolete inventory. .

Second, although Nike Digital is growing tremendously, its price is very high. SG&A expenses increased 8% in the fourth quarter due to investments in strategic technologies, thereby increasing the company’s direct variable costs. As the company begins to put more emphasis on digital sales, expect it to invest even more in this initiative, especially in China. In today’s environment, where inflation remains high and the threat of a recession looms, spending big is the last thing any business wants. But the company has no choice and, as such, these higher investments should be a major drag on the profitability of the company in the short and medium term.

Finally, the company’s problems in China continue to cause it headaches. The company was already facing problems in the region, and those problems have now been exacerbated thanks to the country’s strict COVID lockdowns. The company already expects revenue growth to slow in the first quarter of FY23 as it attempts to recover in China. Revenues and operating margins fell 20% and 55% respectively in the fourth quarter. While Nike Digital has brought some relief, it will be some time before the company can find its footing in one of its biggest markets.

Evaluation

Target price $125.33
Article Projections for FY23
Sales

$49 billion

(5% YoY growth)

Gross margins

45.5%

(down 50 basis points)

FY23 projected gross profit $22.3 billion
General and administrative costs

$15.98 billion

(8% YoY growth)

Tax rate 15%
Projected net income $5.37 billion
Number of shares outstanding 1.6 billion
Projected EPS $3.36
Historical forward P/E 37.3x

Source: Author’s projections and company press release for the fourth quarter

The company expects revenue to be flat for double-digit growth on a currency-neutral basis. So I’m assuming revenue is 5% (midpoint of company estimates), which translates to $49 billion in revenue for FY23.

Gross margins are expected to be flat or down 50 basis points. Given the headwinds the business is facing in the current climate and the issues plaguing the business in China, I expect gross margins to decline by 50 basis points, translating to gross margins of 45, 5% for fiscal year 23.

The company’s general and administrative expenses are expected to decline from high single digits to low double digits. I assume these expenses will increase by 8%, consistent with the FY22 growth figure, which translates to an SG&A of $15.98 billion.

The tax rate is expected to be in the mid-teens, so I’m guessing it’s 15%. Thus, FY23 net income is expected to reach $5.37 billion.

According to Refinitiv, the number of shares outstanding to calculate diluted EPS is 1.6 billion. This would give diluted EPS of $3.36. The historical PER of the company is 37.3x.

This translates to a price target of $125.33, which implies a 16% upside from the closing price on July 07, 2022.

Final Thoughts

Nike’s stock was hurt by both the current macroeconomic environment and the continued headwinds it faces in one of its most important markets, China.

These challenges seem far from over. High shipping costs, higher investments needed to grow its digital business, and the massive rebuilding work it has on its hands in China are all significant headwinds the company faces in the short to medium term.

From a valuation perspective, the stock appears to be undervalued and current levels seem like a good place to initiate a long-term position. Moreover, the huge growth potential of its digital business as well as the steps the company is taking to realize its Metaverse ambitions are proof that the future of the company is secure.

In the short term, however, expect more pain as the current macro climate really tests the resilience of the business.

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