Nike (NYSE:NKE), which operates in the apparel, athletic footwear and accessories industry, had a lackluster last quarter (4Q2012), which led to a decline of 9% in the stock price. However, we believe that NKE has the fundamental strength, continued revenue growth, and long term growth opportunities, which all make it a buy.
Nike missed 4Q2012 analyst estimates for EPS, but met the revenue estimates, which resulted in a stock price decline. The company reported EPS of $1.17 as compared to analyst estimates of $1.37 and Q42011's $1.24.
The full year earnings of $4.73/share were below analyst expectations of $4.92/share, but above 2011 full-year EPS of $4.39. Same was the case with full year revenues. Revenues of $24.1 billion were slightly below analyst estimates of $24.2 billion, but were 15% more than 2011 revenues.
Though the revenues have increased across all geographies and categories, margins have dropped slightly. For 4Q2012, gross margin was down by 1.5 percentage points, and for the full year it was down by 2.2 percentage points. This is because of currency impacts, higher product costs, higher discounts on sales, investment in digital infrastructure and unexpected import-related custom assessment in emerging markets. In 2012, out of the 8 geographical operations, only Europe showed a YoY decline in EBIT.
Future orders for June to November delivery are up 7%, taking in account the exchange rate effect. North America leads, with orders rising by 15%, followed by emerging markets with a 10% rise. Only Western Europe and Japan showed declines in orders (2% and 6% respectively). We expect other territories to keep compensating for the weakness in Europe in the near future. Europe provided around 22% of the total 2012 revenues, with North America providing 37% and China providing 10%. The growth in sales of consumer goods in China (a key market for Nike) is still double digit (13.2% for the month of August YoY), though it has slowed from 17% last year. Retail sales for "Garments, Footwear, Hats and Knitwear" showed a 21% increase YoY.
On May 31, 2012, the company had announced its intentions of divesting Cole Haan ($535 million in 2012 revenue) and Umbro ($262 million 2012 revenues), in order to focus on other brands (Nike, Jordan, Converse and Hurley). In 2012, the combined loss from these brands before interest and taxes was $43 million, more than 2011's loss of $18 million. This is in line with the company trying to focus on larger growth areas.
Total debt-to-equity is 3.71%, which is very low as compared to Adidas' (OTCQX:ADDYY) 30%. Cash flow from operations increased BY 5% in 2012 over 2011. The company has a revolving credit facility of $1.5 billion till 2016, and a $1 billion commercial paper program.
It has a dividend yield of 1.5% with a payout ratio of 29%. The company has been increasing dividend every year since 2002. The free cash flow yield is 1.5% (trailing twelve months).
Nike has a share repurchase program of $5 billion, which spans 4 years since September 2008. $4.1 billion shares have been repurchased, which leaves behind $900 million.
Valuation and Recommendation:
The forward P/E for NKE is 17x, for Puma (not listed in the U.S.) is 17.7x, and for Adidas it is 14.5x. The last 5-year average P/E for Nike is almost 18x. At these forward and average multiples, the valuations come out to be:
*FY2015 EPS have been calculated by applying an 8% growth rate on FY2014 EPS
The consensus target price for NKE is $105. The short ratio is 2.1 days. The 52-week high is $114. This means that NKE is trading at a discount of approximately 15% to its 52-week high.
We recommend buying Nike even after the weak Q42012 earnings, as the company still has strong fundamentals and analysts expect a long term earnings growth rate of 8%. Investors can benefit from an upside potential given that the company is focusing its efforts in those parts of the business which have the largest growth potential.