Nike (NYSE: NKE) had a phenomenal quarter, and I say phenomenal simply because it delivered decent numbers despite a turbulent market environment. And the future looks bright for the company thanks to the huge strides it is making in the digital marketplace as well as the metaverse. However, in this article, I outline why I am neutral on the stock in the short to medium term due to a challenging market environment and limited upside potential from a valuation perspective.
Digital market and investments in the metaverse: catalysts for future growth
Let me start by focusing on the positives of Nike. First, the digital dynamic of the company is gaining momentum. Nike Digital, its digital marketplace, is proving to be an effective growth catalyst. It is the company’s fastest growing revenue driver and now accounts for 26% of the company’s brand revenue. In the just-ended quarter (Q3) digital revenue grew 22% on a currency-neutral basis, as the segment also saw significant improvement in conversion rates and lower customer returns.
The increase in conversion rates on Nike Digital can primarily be attributed to the company’s consumer engagement strategy. For example, Nike’s digital app, SNKRS, which keeps sneaker fans up to date with new releases, has been a huge hit. The app’s audience has quadrupled since the company started livestreaming its product launches last year. In addition to SNKRS, the company has also used Snapchat’s Try On lens and a partnership with Fortnite to improve consumer engagement. All of these various consumer engagement initiatives are paying off, making Nike Digital a strong catalyst for future growth.
Then there’s the company’s Metaverse push. Nike’s virtual world, NIKELAND, built on Roblox, has received visits from over 6.7 million players from 224 countries to date. During NBA All-Star week last month, the company had none other than LeBron James coaching and engaging with players on the court at NIKELAND. Additionally, in the third quarter, Nike’s recent acquisition, RTFKT, released the first official Nike brand NFT, which is expected to create more inroads in the world of digital product creation. Most recently, as part of the company’s “Air Max Day” celebrations (an annual festival to celebrate the company’s iconic Air Max sneaker), the company invited kids to create a digital world with a Air Max theme. “Airtopia”, as the digital world is called, is not only an example of the breakthroughs the company is trying to make in the metaverse, but it is also another strong example of consumer engagement, especially more than they extended this invite on the back of the release of the first kids Air Max show.
The Global Metaverse Market Size Is Expected To Reach $678.8 billion by 2030, according to Grand View Research Inc., with a CAGR of 39.4%. The retail industry has much to gain from the digital world given the opportunities and andvery big brand has already started planning it. However, the actions taken by Nike so far suggest that it has all the necessary ingredients to dominate this market in the future.
The future may look bright, but too many landmines today
Now let’s move on to the reasons that dampen my enthusiasm for Nike. While supply chain issues are slowly easing, with factories in Vietnam fully resuming operations and nearly all of the company’s suppliers resuming operations without restrictions, transit times continue to remain high. Management on the recently concluded earnings call reported transit times were now more than 6 weeks longer than pre-pandemic levels and 2 weeks longer than the same time last year. last. Due to these long transit times, inventory jumped 22% year-over-year, with transit inventory now accounting for 65% of the total. Although these figures are significantly better than those of its counterpart Lululemon Athletica (LULU), it remains a major risk for the company, at least in the short term, and it offsets the positive news from Vietnam.
Second, there is inflation, which continues to be as endemic as ever. Although the company has managed inflationary pressures remarkably well in North America, with third-quarter sales in the region jumping 9% year-over-year, it is extremely difficult to bet on a scenario where the company would repeat this feat in future quarters. Management has already highlighted how the fourth quarter is expected to see a negative inflation impact due to the low single-digit price increase implemented on its products. With inflation likely to last much longer than originally anticipated, especially with the Ukraine-Russia war acting as a new catalyst, in the short to medium term things look expensive for Nike.
Finally, there is the problem of China. Sales decreased 8% on a currency neutral basis and EBIT decreased 19% in the third quarter of FY22. Although management suggested that the third quarter saw sequential improvement, the consequences of the strict COVID-related lockdowns in the region are not yet fully understood. China has been a major issue for the company lately and with COVID lockdowns reach major cities in the region, it is difficult to see sales increasing substantially in the region anytime soon.
Nike stock valuation
Nike expects FY22 sales to be mid-range. Therefore, I’m assuming 5% sales growth for FY22, which translates to $47.2 billion. Given the multitude of risk factors, which I described in the previous section, I assume a modest 7.5% sales growth for FY23, which translates to approximately $50.75 billion . Using the current number of shares outstanding of 1.58 billion (Source: Refinitiv), this would translate to revenue per share of $32.12. The company’s historical median P/S according to Refinitiv is 4.5x. If I apply that multiple to sales per share, that would translate to a price target of $144.50, which is just 4.3% upside from the March 30, 2022 closing price.
Therefore, while the company’s long-term outlook looks fantastic, from an investment perspective, current levels are not ideal for initiating a new position in the stock.
Overall I like Nike. The company has moved with the times and adapted brilliantly to the ever-changing climate. His focus on the digital market combined with the significant inroads he has made in Metaverse are powerful catalysts for future growth.
That said, in the short to medium term, I’m not sure that current levels are a good entry point for long-term investors, given the myriad of risks the company faces. Additionally, from a valuation perspective, the company appears to be more or less evenly valued, with a price/forward multiple giving a price target of $144.50, which is an upside of just 4.3 % compared to the closing price on March 30, 2022.
However, any further decline and/or fundamental change in the market environment should encourage investors to do so, the “it” being to initiate a position in this retail giant.