By David Tumm, Benzinga Staff Writer
Nike (NKE) traded down as much as 12 percent following its June 28 release of fiscal year-end financial results. The decline can likely be explained by Nike's disappointing quarterly income statement. For value-oriented investors, Nike's current price level may be an attractive entry point.
In Nike's most recent release, the company reported its largest quarterly revenue in its history. Revenue increased 12 percent to $6.5 billion. The increase in revenue was shared across all geographies, key categories and product types. However, the 12 percent drop in market value likely stemmed from Nike's lower gross margins and higher Selling, General & Administrative (SG&A) spending. These two metrics contributed to the company's lower than expected earnings per share (EPS).
For the quarter, Nike's gross margin was 42.8 percent. On a year-over-year basis, this represented the sixth consecutive quarterly drop in gross margins. Higher per unit production costs were responsible for the drop in gross margin as these costs exceeded the positive effects of pricing increases. The company's SG&A expenses were up 12 percent to $2 billion.
In addition, Nike's net income decreased around 8 percent to $549 million for the quarter. This net income translated to earnings per share of $1.20, $0.17 lower than the analyst expectation.
In order to determine whether Nike's recent loss in market cap is justified, investors might consider the company's historical performance over a longer time frame. For example, prior to its most recent release, Nike had exceeded analyst EPS expectations in 22 of the last 23 quarters.
When examining Nike's balance sheet, investors might notice an inventory build-up. Inventory on May 31st, 2012 was $3.4 billion, up 23 percent from May of 2011. Most of the increase in inventory can likely be explained by higher product costs, which also contributed to a decline in gross profit margin.
Cash and short-term investments at the end of the period were $3.8 billion, which was $781 million lower compared to last year. This was largely due to higher working capital investments, long-term debt repayments, and dividend payments compared to last year.
For investors with a longer-term focus, the inventory build-up may not be of much concern. Nike has demonstrated that it retains significant control of the pricing of its products. Also margins could improve as fuel and cotton costs begin their cyclical easing.
Notably, Nike's recent share price decline makes the firm cheaper relative to other athletic apparel manufacturers. For example, Under Armour (UA) and Lululemon Athletica (LULU) both trade at over 30 times next year's earnings. Nike trades near 15 times forward earnings. Although Nike is a mature company, several potential near-term catalysts could make it an exciting growth story.
Nike is now the exclusive provider of NFL uniforms. The five year deal not only means Nike will sell more jerseys, but the company will be in the spotlight in front of one of the largest audiences in the world.
Investors who believe Nike is oversold could consider several options strategies. One such strategy is an out of the money bull call spread. This strategy involves two actions. The first action is purchasing a call option with a strike price above the current stock price. The second is selling a call option with a strike price above the strike price of the purchased call option. The money bull call spread strategy can be highly profitable if the stock rises. To give time for market participants to notice if Nike maintains a strong long-term growth strategy, investors might consider buying and selling calls with October 20th 2012 expiration.
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