Nike Stock: What to expect after a 40% price drop (NYSE:NKE)

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Joe Raedle

Thesis article

Nike (NYSE: NKE) will release its first-quarter results on September 29. The company has seen its share price drop significantly in recent months due to a variety of factors. We will examine the probability of another earnings beat and what investors should watch out for when Nike releases its next earnings report.

A very weak performance from Nike since the beginning of the year

Like many other consumer goods companies, Nike has seen significant tailwinds during the pandemic due to a few macro trends. First, the lockdowns meant that consumers couldn’t spend as much money on experiences as before the pandemic, such as eating out, traveling, going to concerts, etc. They therefore had more money to spend on goods, which was beneficial to producers and sellers. consumer goods, including discretionary goods that are purchased when consumers have money to spend but are not needed (unlike beverages, food, personal care products, etc.). On top of that, massive fiscal and monetary stimulus spending has further increased consumers’ purchasing power, allowing even more people to buy all kinds of goods that are not really needed. Nike, as one of the world’s leading consumer discretionary companies, has benefited from this trend.

Its stock price reflected this, quickly surpassing pre-pandemic levels once the initial COVID-induced bear market ended:

NKE Stock Chart 2022
Data by Y-Charts

From a price of around $100 per share at the start of 2020, Nike fell to $180 at the end of 2021. Since then, however, the shares have fallen sharply. This year alone, Nike has fallen more than 40%, destroying tens of billions of dollars in shareholder wealth.

There are several reasons for this. First, stocks were trading at too high a valuation while enthusiasm was very high. At the end of 2021, Nike was trading at an earnings multiple of 45. At the same time, the median 10-year earnings multiple is in the high 20s. Buying an established blue chip company at an earnings multiple well over 40 hardly works well in the long term, and Nike proved this once again in the following months – valuation matters, after all. , regardless of the type of business we are talking about.

But Nike also faces several macro headwinds, so the price drop wasn’t just due to multiple normalization. First, as a consumer discretionary company, Nike is affected by declining consumer purchasing power. While food companies or toothpaste manufacturers will be able to sell their products no matter what, consumer discretionary companies are impacted when consumers spend less. Consumers are reducing their spending on “needs” in the current environment for two reasons. First, high inflation reduces their purchasing power and leads to a higher allocation for items such as food and energy, which reduces the purchasing power available for products such as shoes or new clothes. . Second, it looks like the United States and the world as a whole are entering an economic downturn, which will likely further reduce consumer spending – some people will lose their jobs and others will be more inclined to hold on to their money in times uncertain.

Nike’s sales outlook has therefore deteriorated, and at the same time margins are under pressure due to rising costs of materials, energy, etc. So it’s no surprise that analysts aren’t predicting compelling growth for Nike’s upcoming quarterly results. In fact, Nike is expected to increase revenue by just 0.3%, according to Wall Street. When we factor in high single-digit inflation, that means sales will actually be down significantly in real terms.

Worse still, analysts predict that Nike will only earn $0.92 per share. This is 21% less than the profit generated by Nike in the prior year period in real terms, and a drop in profits of almost 30% in real terms. As noted above, the combination of sluggish earnings due to weak consumer sentiment and rising costs will put significant pressure on Nike’s earnings.

Regarding the revisions of the estimates, it is quite clear that the deterioration of the macroeconomic situation (inflation and recession) has left its mark. Earnings per share estimates for the first quarter have fallen nearly 30% over the past six months, while EPS estimates for the second and fourth quarters are also down double digits. Wall Street has deteriorated on Nike, at least to some degree, and the stock price reflects that the broader investment community has also turned more bearish.

Will the Beats continue in Nike’s Q1 earnings?

That being said, Nike has a history of exceeding expectations. Over the past ten quarters, Nike has managed to beat earnings-per-share estimates nine times, and revenue estimates have also been beaten more times than they have been missed. It is therefore not unlikely that Nike will beat current expectations and announce a higher than expected net profit for its first fiscal quarter. I still doubt Nike can keep its earnings from falling, but it wouldn’t be too surprising if Nike reports a lower than expected earnings pullback. If history is any guide, actual earnings per share results could come closer to $1 from the current consensus of $0.92 – but that would still mean a drop in the mid-teens from the l quarter. ‘last year.

A recent trend of Nike Direct outperforming Nike Wholesale is likely to remain in place. Significant spending to boost its direct sales channels and the overall trend of online sales growth will continue to benefit Nike Direct sales. At the same time, wholesale trade could feel the majority of macro headwinds, such as weak consumer sentiment, prompting people to buy fewer discretionary items. This would be in line with reports from brick-and-mortar retailers of high inventory levels and slower-than-expected sales – see, for example, recent comments from Target (TGT) and Walmart (WMT).

With Nike shares down so much this year, it will be interesting to see what management has done on the capital allocation front. The company isn’t offering too high a dividend yield, at 1.3%, but it has indicated it is keen to buy back shares at current valuation levels. During the last quarterly report, Nike announced a new $18 billion share buyback program. This equates to approximately 12% of the company’s market capitalization today. Given that the shares have fallen further since the last earnings announcement (down about 10% or so), management should, in theory, be even more eager to capitalize on the current weakness in the share price. Using a significant portion of the current repurchase authorization would significantly reduce Nike’s stock count, increasing the company’s prospects for future earnings-per-share growth. At the same time, a steady pace of buybacks could offer some support for the drop in Nike stock price. Right now, Nike is in a blackout period ahead of the earnings report, so there probably won’t be any buyouts. But a few days after the announcement of the results, redemptions could start again. Investors should look for potential clues about this in management’s remarks. Since Nike has fairly low debt levels — its net debt is even negative when taking into account cash held on the balance sheet — the company is in a position to significantly increase shareholder returns if it chooses. Due to its healthy balance sheet, rising interest rates are not a threat to Nike after all.

Is the NKE share attractive today?

It’s pretty clear that Nike was unattractive at the start of the year. Paying a valuation well above average is very risky, after all. Today, however, things are different. Based on the current forecast for this year’s earnings, Nike is trading for 26 times this year’s earnings. That’s slightly below the median 10-year earnings multiple, so Nike isn’t historically expensive today. Instead, it trades close to fair value, arguably slightly below.

At the same time, we don’t yet know how deep the current economic downturn will be. So I’m hesitant today to buy a consumer discretionary company. Overall, I’m neutral on Nike right now. From the evaluation point of view, the title does not look bad. The relative strength index reading of 32 also implies that stocks may be oversold at the moment. Finally, Nike could significantly increase shareholder returns and repurchase stock at a brisk pace if it decides to use the current authorization.

But buying a consumer goods company might make more sense once the bottom of the recession/economic downturn has been hit. So I find Nike neither particularly attractive nor unattractive at current prices, although a better/worse than expected earnings report could change that when NKE releases its reports in a few days.

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