Nike: Correction Due To Margin Pressure And Inventory Growth

Mar.26.12 | About: Nike Inc. (NKE)

Shares of Nike (NYSE:NKE) took a beating on the final trading session of the week after the world's largest apparel and footwear producer continued to experience margin pressure. Investors are taking profits and sending shares 3.2% lower

Third-quarter results
Nike reported a 7% increase in its net income to $560 million. Earnings per share came in at $1.20 above analyst consensus of $1.17
Revenue advanced 15% to $5.85 billion, just ahead of analyst expectations. Orders for the final quarter of the book year, a good indication for next quarter's revenue, rose 18% year-on-year, which exceeded the analyst consensus of 13%.

Margin pressure
Gross margin compressed by 2 full points to 43.8% exceeding Nike's own expectations of 1.5 points. Margins have been under pressure due to labor and raw material costs. The company introduced a widespread range of price hikes earlier this year and has started to cut costs in order to stabilize margins.

Inventory growth
Worldwide inventories rose 32% year-on-year to $3.35 billion.
Nike explained that most of its inventory growth was driven by strong demand from North America and emerging markets as well as a general build up toward the Olympic Games in London this summer. Furthermore rising input costs drove up inventory balances.

Valuation
Investors value Nike at roughly $50 billion. If we subtract the net cash position of roughly $5 billion, this values the operating assets around $45 billion.
For the first nine months of the fiscal book year of 2012 Nike generated $17.7 billion in revenue, up 17% on the year. This implies that the company is on track to generate between $23-$24 billion in annual revenue, which values the company at 1.9 times annual revenue.
Net income is up 9% to $1.67 billion, due to margin pressures cited earlier. Full year 2012 net income should come in at around $2.3 billion implying an earnings multiple of around 20 times.

Investment thesis
Nike had a great run returning over 40% over the last year amidst a booming global equity market. Nike's revenue growth accelerated as innovation in footwear and running devices is paying off.
Nike's valuation has become quite stretched vs. its main German competitor Adidas (OTCQX:ADDYY) and there are little drivers that could drive up the price in the short term.

I reiterate my standpoint: Investors in the apparel industry should prefer Adidas over Nike.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.