Nike: Valuation Is The Primary Issue

| About: Nike Inc. (NKE)

The share price of Nike (NYSE:NKE) has appreciated by 22% year to date. Although the stock has recently traded off from its 52-week high, the current price level does not represent a good entry point based on the following reasons:

1. Nike shares are somewhat expensive relative to the comps. According to the table shown below, Nike's consensus revenue and EPS growth estimates are generally below the comps averages (though its short-term EPS growth estimate is fairly in line). However, the company's various profitability margins and capital return metrics are mostly above par. In terms of leverage and liquidity, Nike carries a lower debt load and has an above-average free cash flow margin. Both the firm's current and quick ratios are above par, reflecting a healthy balance sheet condition.

Even with the relatively weaker growth potential, Nike's current forward EBITDA multiple is 33% above the comps average. Although the stock's forward P/E multiple is just 7% above par, after accounting for the long-term EPS growth potential, its 5-year PEG ratio is 41% higher, reflecting a somewhat stretched valuation on a relative basis (see chart above).

2. From a historical standpoint, Nike's valuation would also seem to be frothy. The stock's trailing P/E multiple has expanded by 25% over the past 3 years and is now near the 3-year high (see chart below).

However, the company's consensus quarterly revenue and EPS estimates for the current and next fiscal years are not showing a significantly improving trajectory relative to the historical level (see charts below). In addition, the firm's EBITDA margin is forecasted to only rise modestly from its recent level but remain in line with the historical level in 2010/2011 (see chart below).

3. Nike shares are trading at a 37% forward P/E premium over the S&P 500 Index, whose forward P/E stands at 15.2x now. In my view, the current market premium implies a full valuation based on the facts that 1) Nike's consensus 5-year earnings growth estimate at 11.6% is above the average estimate of 8.2% for the S&P 500 companies; and 2) the stock's 1.3% dividend yield is below the market average at 2.1%.

4. Of the total 25 analyst ratings compiled by Thomson One, although there are 11 strong buy/buy ratings, analysts' average 1-year price target of $64.32 is only 2% above the current share price. Given that Nike should command a cost of equity of at least 7% based on the capital asset pricing model (see chart below), the Street's average price target actually implies that the stock is slightly overvalued and has an unfavorable risk-reward profile.

Although Nike's fundamentals continue to be solid as reflected by its rising consensus EBITDA and EPS estimates (see charts below), I would not recommend directly buying the stock at this level for margin of safety reasons. Instead, investors should either wait for a pullback or sell some out-of-money put options to establish a long position.

All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NKE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.