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Introduction

Increased competition in the sports industry is putting pressure on Nike (NYSE:NKE) common stock which will probably continue to underperform the market. This comes at a time when Europe, a major market for Nike's products, is in an unpleasant recession. Even compared with its peers that are focused primarily in the U.S., such as VF Corp (NYSE:VFC), Lululemon Athletica (NASDAQ:LULU), and Under Armour (NYSE:UA), Nike's shares are not cheap when accounting for expected growth. Based on past results, expectations from Nike are high. Importantly, there is only a small margin of safety if this sporting goods company stumbles on its path to dressing and equipping athletes across the globe.

Fundamentals and valuation

Nike, VF, Lululemon and Under Armour have 901, 110, 144 and 105 million shares outstanding, respectively, for a market capitalization of about $49, $18, $9 and $5 billion, respectively. As seen from the table below, all four companies have low to no leverage. There are more similarities between the smaller Lululemon and Under Armour and the larger Nike and VF, that can be explained by their similar sizes and stages of development.

Remarkably, Nike and VF have over 20% of sales coming from Europe, which is undergoing financial and economic crises with no solution on the horizon. Lululemon derives its sales mostly from the U.S. and outside the U.S. from Canada, Australia, and New Zealand, markets that are showing economic growth. And Under Armor is primarily focused on the U.S. market. Overexposure to Europe does not bode well for Nike.

A similarity that all four companies have is their price-to-earnings-to-growth ratio (PEG). Based on PEG, VF and Under Armour seem slightly more attractive than Nike and Lululemon. Also, all four companies have significant insider ownership, which is a positive for common shareholders.

While Nike, VF, Lululemon and Under Armour gross margins are comparable, Nike has one of the lowest gross margins. This indicates that despite its large size, Nike is not able to control expenses as well as its competitors. On the positive side, Nike may have more flexibility in reducing its expenses and improve margins going forward.

Lastly, Nike has the largest marketing expense as a percentage of revenues and in dollars. It seems like Nike is over dependent on advertising. This could also be a positive, as the company can improve its performance in the future by reducing its marketing expense. In fact, there were reports that Nike has already moved its social media activities in-house. The recent problems with major athletes that Nike endorses, including Lance Armstrong and Oscar Pistorius, could speed the move to spending less on advertising and endorsements. However, most endorsement contracts are long term in nature and Nike may not be able to exit them quickly.

NKE

VFC

LULU

UA

Enterprise Value [EV]

$45.8b

$19.4b

$9.4b

$5.0b

EV/EBITDA

13.5

11.2

24.8

20

EBITDA

13.9%

15.3%

30.1%

13.7%

Dividend yield

1.5%

2.1%

0.0%

0.0%

Beta

0.9

0.9

2.2

1.5

Price-to-earnings (2013)

20.5

15.2

35.9

34.7

PEG

1.5

1.3

1.6

1.4

Price-to-sales

2

1.7

5.9

2.9

Price-to-book value

4.8

3.5

12.4

6.4

Europe % of revenues (last annual report)

25%

22%

0%

~3%

U.S. % of revenues (last annual report)

42%

63%

54%

~90%

Insider ownership (last proxy)

74.8% of Cl. A

16.6% of Cl. B

~20%

30.20%

71.7%

Price-to-CFO

19.1

13.9

34.2

26.5

Gross margin

43.2%

46.0%

55.5%

48.0%

Marketing costs as % of revenue (last annual report)

11.2%

5.3%

*

11.2%

One-year total return

-3.1%

10.7%

-9.8%

4.8%

* Lululemon has a small marketing and promotional budget as the company advertises through "grassroots" campaigns and does not breakdown marketing expenses. EBITDA - earnings before interest, tax, depreciation, and amortization; PEG - price-to-earnings-to-growth; CFO - cash flow from operations. Data as of March 18, 2013.

Recent developments

While Nike is gaining share at brick and mortar stores such as Dick's Sporting Goods (NYSE:DKS) and Foot Locker (NYSE:FL), the company has increased domestic competition from established brands as well as relatively new comers, including Lululemon and Under Armour. In addition, more brands are launching or expanding their sport offerings such as Hugo Boss (OTCPK:BOSSY), Ralph Lauren (NYSE:RL), and even Crocs (NASDAQ:CROX). It seems like Nike is falling into a "no man's land" by not being able to differentiate. Nike is currently too expensive to be an everyday brand and too cheap to be a luxury brand.

Competition in athletic footwear is also intensifying by the popularity of the five finger running shoe made by Vibram and by other newcomers targeting the increasingly popular sport of running. Also, Adidas recently launched its new line of running shoes, Boost, which is competing directly with Nike's Flyknit Lunar1+. Assics, Mizuno, Reebok and New Balance are other established brands with significant share in the sport of running.

The recent sale of two distinguished brands (owed by Nike) to private equity firms, Umbro for $225 million (sold at a loss) and Cole Haan for $570 million, could further decrease sales and the ability to compete with more specialized brands. Also, the sale prices were near each brand's 2012 sales ($262 million for Umbro and $535 million for Cole Haan). This is significantly lower than Nike's current price-to-sales ratio of two. The sale of Umbro, the historical English football brand, is particularly alarming as soccer is the most popular game in most emerging markets that Nike hopes will contribute to future growth.

Conclusion

Shares of Nike appear fully valued with risks likely outweighing the opportunities. The recent sale of two of its leading brands and significant exposure to Europe could put short-term pressure on the stock. In the long term, Nike has competition from both established and relatively new companies. Its recent expansion into electronics, an area that requires significant research and development and where new products could emerge quickly, could also prove to be riskier than expected.

Finally, Nike may not have the power to increase prices due to higher inflation pressures from raw materials, labor and endorsement contracts. This could cause its long-term margins to erode. It seems like investors in this iconic brand could be better served if they put Nike's shares in a permanent timeout.

Source: Nike May Have To Go In Timeout