In our last article on Nike (NKE), we analyzed the revenue potential from the upcoming World Cup and the impact on the company's EPS from its ongoing share repurchase activity. Moving ahead, we reiterate our high hopes with respect to its new objectives, outlined at the investor's day meeting held on October 9, 2013. In this meeting, Nike showcased what revenue opportunities lay ahead for the company on various fronts.
In this report, we will discuss what is the further earning potential from its most profitable segment "Converse" and what Nike should expect from further expanding into the women's apparel business.
Converse brand, the most profitable segment
In the last fiscal year ended May 2013, Nike generated around $1.45 billion in revenue, representing a 9% rise year over year. Moreover, in Nike's latest quarterly results, the Converse brand witnessed 16% revenue growth year over year. This was coupled with a year-over-year increase of 36% in earnings before interest and taxes, or EBIT, to $169 million. Nike has generated lucrative results from the segment despite the fact it bought Converse for just $305 million 10 years back.
Such results from Converse were witnessed due to sales growth in owned markets, which includes the U.S., U.K., and China. The shift in the revenue mix, especially to the higher margin U.K. region, contributed towards the additional growth in Converse's gross margin. The favorable product mix also complemented the brand's growth.
Since Converse is driven with substantial topline and bottomline growth, this makes it an important segment for Nike. One of the primary reasons for high profitability from Converse is that it doesn't require expensive Research and Development, or R&D, investment. Low R&D cost is because little has changed about Converse brand shoes. Moreover, Converse doesn't require multi-million dollar athlete endorsements, which demand considerable expenses from sportswear giants.
Driven by the cost-effective characteristics of the products under Converse, Nike already increased the store operations for Converse to 72 stores in fiscal 2013, a 16% rise year over year. To enhance the reach of Converse shoes, Nike is concentrating on designing of products under the segment. Better designs increase attention towards the product, so Nike has tapped John Vervatos, a fashion icon, for designing famous Converse branded kicks. Nike will also introduce a program where shoppers can design their own shoes. Low R&D expenses allow Nike to pay special attention to the designs for Converse branded products.
It will continue to diversify the Converse portfolio and will expand the brand's image by making efforts in new market conversions. It will also expand the direct to consumer reach for Converse and convert additional markets for direct distribution of Converse.
Despite of the expansion in the segment and cost effective characteristics of Converse, the revenue from the segment contributed just 5.7% of Nike's last fiscal results, but we expect Converse's revenue share will increase over time. Nike aims to achieve $36 billion in overall revenue by the end of fiscal year 2017. This will call for an average year-over-year increase of 10.45% in overall revenue by the end of fiscal 2017.
Converse's segment revenue is expected to reach $3 billion by the end of the same period. This will lead to an average year-over-year increase of 26.72% by the end of fiscal 2017, which is more than double of the overall growth in Nike's revenue. If the company achieves the above mentioned targets, then the portion of Converse's revenue is expected to reach 8.33% of Nike's overall revenue by the end of fiscal year 2017.
Enhanced expectations from the women's apparel market
Nike's women's business has grown to $4 billion in fiscal year 2013 as compared to $1 billion in fiscal year 2010. The company expects the women's business to grow to $7 billion by fiscal 2017. The women's business is expected to contribute approximately 19.5% of Nike's overall revenue by 2017. Nike's expectations from its women's business are quite justified.
The company introduced an array of products especially for women. It introduced a limited edition of Nike Tight of the Moment, or NTM, style which comes with a sweat wicking Dri-FIT fabric that helps one keep dry in a heated workout. Moreover, Nike introduced Free 3.0 V4 shoes for women, which are versatile shoes made using the latest technology and innovations. Apart from new products, Nike has high expectations from the sneaker culture, which is growing among women. It is seeing an increasing number of women lining up for sneakers, just like men.
With respect to Nike's women apparel market, Nike's younger rival, UnderArmour (UA), aims to spend $250 million this year on marketing, especially to strengthen its position among women customers. According to Citi, both Nike and UnderArmour can benefit from the growing women's athletic market since both companies have improved their women's merchandise over the years.
Both companies are also giving consistent competition in women's wear to lululemon athletica (LULU), one of the most prominent players in the women's athletic wear market. Although lululemon's revenue from women apparels could decline, the brand has its own niche in the women's business.
On the other hand, Nike has maintained its top position in athletic apparel among fickle teen shoppers for the third consecutive year.
Comparison with peers
UnderArmour and lululemon have considerable potential to compete with Nike in the women's apparel business.
Source: Yahoo finance
With respect to revenue generation, Nike has performed well in comparison to UnderArmour and lululemon; it has the lowest EV/Revenue at 2.30. With respect to profitability, it has been generating considerable profits with respect to enterprise value and has the lowest EV/EBITDA at 14.85. Moreover, Nike still has better potential to improve its topline in comparison to its peers since it is has the lowest Price/Sales at 2.44.
We were bullish on Nike in our last report and expect the same after going through the opportunities it revealed at its investor's day held on October 9, 2013.
Moreover, UnderArmour and lululemon are the fastest growing companies in U.S., but Nike has ample potential to grow, which is evident by its lucrative valuation multiples.
Nike knows the opportunities that lay ahead with its Converse segment and has already started working to capitalize on it. We believe that this stock will continue to impress investors.