It should come as no surprise that Nike, Inc. (NYSE:NKE) has been doing well this past year, and has in fact reached a peak in investments in 2013, due to the upcoming FIFA World Cup. However, the athletic retailer's popularity amongst investors commenced far longer ago, and its revolutionary technology, size, brand image, and competitive advantages have earned the firm a wide economic moat, making it the leader of the athletic footwear and apparel industry.
Although Adidas (OTCQX:ADDYY), Puma, and Reebok compete for the industry leadership position, Nike is always one step ahead, resulting in a very strong balance sheet and significant financial results. And Q3 of 2013 was no different. In fact, the Nike Flyknit platform, which develops products for football, basketball, and running, using highly advanced knit technologies, has been a real success. As production costs decrease in the near-term future, in addition to the amount of possible customization, the platform will become a real money maker and highly popular amongst brand loyal customers.
I believe it's also needless to say that Nike's impeccable marketing and publicity team have helped earn consumer's loyalty and trust, which will certainly persist in the long run and continue to drive impressive growth. So, in the article below, I will analyze this athletic retailer's past profitability, capital, and operating efficiency, in addition to looking at which institutional investors have recently bought the company's stock in the last quarter. Based on this information, we will get an understanding of the retailer's revenues, operating metrics and quality of earnings.
Profitability is a class of financial metric used to analyze a business' ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, I will study several profitability metrics, such as return on assets, quality of earnings, cash flows and revenues, which will allow us to elucidate if Nike is really making money.
ROA - Return On Assets = Net Income/Total Assets
ROA is an indicator of how profitable a company is relative to its total assets, and it gives us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. In simple terms, this metric tells you what earnings were generated from invested capital (assets).
I am encouraged by the fact that Nike's ROA has increased from 14.50% to 15.04% over the past 3 years, since it indicates that the company is generating more from its assets than it did in 2010.
Quality of Earnings
Quality of earnings is the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies - such as inflation of inventory. In order to assess Nike's quality of earnings we will compare the level of income with operating cash flows.
The company augmented its profits at a rate of 27%, but the growth of cash flows was higher. This is strong evidence of profits being created through a boost in sales or cost reductions.
Working Capital measures both a company's efficiency and its short-term financial health. This ratio indicates whether a company has enough short-term assets to cover its short-term debt. While anything below 1 indicates negative W/C, a ratio above 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
Nike's current ratio (working capital measurement) increased from 2.85 in 2010 to 3.47 in 2012. This shows that the company has a strong balance sheet and can pay off its obligations. Looking for companies with current ratios above 1 is a must for long-term investors.
This athletic retailer's knack for superior product development and tremendous scale have helped establish it as the go-to brand for athletes not only in North America, but worldwide. However, while the U.S. and Canada have delivered surprisingly strong revenue in 2013, it's the Chinese market which will drive future long-term growth. In fact, with $2.4 billion in revenue, Nike is already an industry leader in China and in spite of slowing market concerns, investors should expect the company to continue growing at a solid pace.
Common Shares Outstanding
I like companies that buy back their own shares, diminishing the number of outstanding shares. Nike has done very well in this aspect, buying its own shares in the past 3 years, thus decreasing the number of shares outstanding from 971 in 2010 to 916 in 2012.
Gross Margin: Gross Income/Sales
The gross profit margin measures a company's manufacturing and distribution efficiency during the production process. It also tells investors what percentage of revenue/sales is left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors -and overall industry- is more efficient and investors will tend to pay more for these businesses as they should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
Over the past three years, Nike's gross margin has decreased slightly from 45.6% in 2010 to 43.6% in 2012. A decreasing margin indicates that the company has been becoming slightly less efficient year-after-year. However, in this case, the margin is still at a very healthy level compared to other industry players.
Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue - the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover.
The fact that Nike's revenue growth has outpaced its assets growth (08% growth) on a percentage basis, indicates that the company is making money on its assets.
It is important to check which hedge funds bought the stock in the last quarter and at what price they did so. I assume that if a prominent institutional investor put money into Nike, then the stock will pass strict fundamental standards. Thus, I feel encouraged by the fact that Paul Tudor Jones and Bill Frels bought the stock in the past months at an average price of $75.07, because it shows that hedge funds have confidence in the stock.
Currently, many analysts have a good outlook for Nike. Analysts at MSN money are predicting that the firm will retrieve EPS of $2.99 for FY 2013 and EPS of $3.48 for FY 2014, consistent with the 11.7% growth rate. Bloomberg's analyst team, on the other hand, is estimating revenue to continue its 12.8% growth pace, jumping from 2013's $27.74B to $30.15B for FY 2014. Furthermore, on 30/10/2013, Morgan Stanley gave Nike a rating of "Overweight" with a target price of $81.36, implying significant upside potential from this point.
All in all, I think most investors will not be surprised by my recommendation to buy Nike's stock, although I don't think this is the precise moment. The stock's current trading price of 24.9x trailing earnings is sporting a 35% price premium relative to the industry average of 18.5x, which I believe is due to the imminence of the FIFA World Cup. In fact, the shares haven't sold at this high a premium since 2004, and once the World Cup passes, the P/E ratio should normalize closer to the industry average. Nonetheless, there is no doubt in my mind that Nike will reap profits in the short term, medium term, and long term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.