Have Investors Jumped The Gun On Nike?
Summary
- Nike's position in North America continues to be under pressure from competitors like Adidas.
- Strong international growth and a continued decline in North America could help overall growth numbers as overseas markets balance out the skew at the top line.
- However, for current valuations to be justified, North America sales have to pick up the pace. Unfortunately, investors may have jumped the gun, before the actual recovery happens.
In a matter of a few months Nike's (NYSE:NKE) stock price has gone up considerably. In fact, after trading near its 52-week lows towards the end of 2017 the stock is now at the opposite end of the spectrum, testing highs it hasn't touched since late 2015.
The problem is, the price is now where it was before the sales decline in Nike's most important market, North America, first began. I think investors have jumped the gun before North America can show positive sales growth once again, thereby inflating share price without the fundamentals to back it up. Although international markets like China do provide a wedge against overall sales decline, the stock's current price can't be justified until North America sales show a full recovery into positive territory.
On August 25, 2017, I wrote an article here on SA arguing that the company is a global brand and not a regional one, and that international revenues have the power to pull the company out of its regional troubles and allow it to keep growing over the long term.
I concluded that article with this:
With long-term growth prospects looking positive, we're not going to see Nike trading at the 20 times earnings levels that often in the future. If you're ready for the long haul, buy Nike and hold it forever.
At the time that article was written the stock was trading at around $53. Since then it’s gone up by more than 20%, now trading near its 52-week highs rather than its 52-week lows. I want to revisit Nike’s position in light of Q2-18 performance to see if investors should wait for a pull back or if the company is still a good buy at the current price point.
My thesis in short: The market has jumped the gun before recovery in North America could be achieved.
Weakness in North America Persists
Despite its efforts Nike continues to struggle in its single largest market, North America, where it continues to lose ground against its competitors, chiefly Adidas (OTCQX:ADDYY).
Source: Nike Quarterly Reports
As you can see from the chart above, Nike’s decline in North America happened slowly, turning from positive to negative over three quarters. The downward trend is yet to be broken, and it might take at least a few more quarters for that negative momentum to snap.
During the Q2-18 earnings call Nike warned of a continued decline in North America, but you’ll have to read between the lines:
For the full year, we continued to expect reported revenue growth in the mid single-digit range. In Q3 in particular, we expect reported revenue growth at or slightly below the rate of reported revenue growth that we delivered in Q2, with the timing of new product launches coming later in the quarter. [Q2-18 Earnings Call]
That means Nike is hoping that its new products will help swing the negative growth trend upward, but the fact that they’re be launched late in the third quarter means they may not make a meaningful contribution. Moreover, a mid-single-digit forecast for FY-18 means Nike still expects flat to negative growth in North America over the next two quarters. That’s implied because EMEA reported 9% growth, Greater China reported 13% and APAC and Latin America posted 7%.
An it’s understandable because, for any fashion brand, trends take time to form - both good ones and bad. Just as it took three quarters for Nike to go from positive to negative growth in its largest market, it’s going to take at least that many to get back to where it was before the decline set in.
Thankfully, Nike’s dependence on the North American market for top line growth is gradually on the decline as well. During the first half of the current fiscal North America revenues accounted for 44.3% of the revenue pie, compared to 47.46% last year. In other words, the longer the growth decline continues in its main market, the better its overall growth rate will be.
In markets like China, the growth momentum has been considerable, especially in the DTC (direct-to-consumer) segment where Nike has renewed its focus.
Source: Sandalwood Advisors
But although international revenues from strong markets like China continue to be a huge face-saver for Nike, the sooner the company gets its North America sales growth back on track the better it will be in terms of valuation. The problem is: the market has moved much faster than Nike, pushing the stock price back up and imposing unnecessary risk on newer investors.
NKE PE Ratio (TTM) data by YCharts
As you can see from the chart above, the trailing twelve months PE ratio is already close to pre-2016 levels, a time when Nike could do nothing wrong in the eyes of its investors. Things look even hotter when you look at the historical forward PE chart (below), with Nike trading at multiples not seen in the last five years.
NKE PE Ratio (Forward) data by YCharts
Investment Case
I’ve always seen Nike as a must-buy for long-term investors willing to hold the stock for ten or twenty years or longer. It’s usually been too expensive, but the window from about mid-August through mid-November was the perfect opportunity to get in at a great price.
However, now that investors have jumped the gun on North America sales performance - and seem to be expecting a quick turnaround, as current PE multiples show - I think it’s time to stay calm and wait for things to cool down again before making your play. With the company already warning investors about a soft Q3, your chance to jump in may well come sooner than you expect. Put it on your watchlist for now and wait for the right moment.
This article was written by
Analyst’s Disclosure: I/we 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.
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Comments (12)
I see North America as an anxiety issue that American investors have to get over and realize it's a big world out there.Stynx.
