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NKE | Fundamentals Save CFO’s ‘Own Goal’

Takeaway: Much better than what the rumormongers feared. The fundamentals are intact. Cloudy and obfuscated. But intact. We’re buyers on weakness.

This Nike print lived up to the hype. Lots for both sides to chew on. We expected that. But the only way the short side could really work – i.e. one of those horrific -10% days with lousy follow through in subsequent weeks – is if there was a big fundamental erosion in the business and Nike backed off its model. Yes, North America Futures were lousy (+1%) but the global numbers looked healthy, inventories are improving on the margin, underlying gross margins looked good, e-commerce growth (+49%) was off the chart, and the organic EPS number beat by a nickel, or 9%. The punchline is that the company is on track to delivering on ‘the hockey stick’ earnings ramp for FY17 (May), and we’re taking our numbers up by more than the 1Q beat to a level that will likely be about 5% above consensus (we’re 30% above by 2019). Maybe the hedge fund community will bat this name around a bit after the noise surrounding this print. But will a long-only PM punt this name because of what Nike just printed? No. Relative to what was rumored before the call, this print was more than good enough for most people to stay put. It certainly is for us.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 9 27 2016 NKE FINANCIALS

 

All of that said, we give the management team a D minus for this call.

  • Parker and Edwards both get an A (rare that we give Trevor Edwards an A). They were poised, thoughtful extremely confident. If there are problems out there, someone forgot to give Nike the memo. Historically, it’s not a profitable move to bet against Nike’s confidence (unless it comes with a strong dose of cocky – and we definitely did not get that sense). Mark has never seen a category or market that he has not been ‘extremely excited’ about growing. In fairness…he’s usually right. Too bad he’s only got about a year left in his seat until he hands the reigns over to Trevor.
  • On the flip side, I give Andy Campion a strong F on this one, and the whole investor communication effort something between a C and a D. How they managed guidance was fine. But reclassifying what we think is 100bps of costs from SG&A into COGS AND changing up the process for communicating futures to the Street AGAIN in a quarter where there are so many questions around the sustainability of growth is simply not cool. Nor is the lack of transparency and quantification of these items.

To be clear, this was a lay-up quarter for new CFO Andy Campion to earn his stripes. My view on almost any job is, you rarely want to step into a role where the person before you was the best of the best. That’s what Campion did. Don Blair was about as good as they come. A great CFO is not revealed when business is going great, but rather when a model is going through a state of transition as Nike is today. Blair would have breezed through this with no problem. Campion did poorly. He actually scored the equivalent of an ‘own goal’ in soccer/football (whatever).  

 

The CFO’s miss definitely won’t help the stock tomorrow, but it has zero impact on our call on this name.

  • TAIL: GM% headed above 50% as mix moves higher and Nike consolidated 3-4x gross profit dollars without the need to gain share as e-comm goes from 6% of sales to 20% over 3-4 years. Ultimately you’ve got near $5 in EPS. A 20x multiple (lower than what you have today) is a $100 stock.
  • TREND: EPS accelerates meaningfully as revenue growth accelerates globally, gross margins trend higher due to DTC and less inventory bloat vs last year and SG&A growth takes a dive due to the Olympic spending hangover.  All in that takes EBIT growth in Q1-Q4 from -11% to 9%, 24% and 37% respectively.
  • TRADE: The near term factors like Adidas/UA share gain, Olympic Trade, Channel Conflict (this is real), Inventory Issues might matter in part to the US market, but the reality is that Nike is a global company. Maybe we see multiple pressure as US investors are pretty myopic on this issue. But Nike guided to mid-single digit US revenue growth – which is probably conservative, and is more than enough for Nike to achieve/beat its guided financial model.

The bears will dwell on the meager 1% growth in futures in North America. Thats what we call ‘pretty much negative’ in Nike-talk. It completely validates the concern about Nike losing share in the US market – sort of. The space is about +4% -- Nike grew 50bps in the quarter (share gain), but then put up an order book of only +1% -- implying share loss. We’d also note that e-comm (which is now included in futures) was up 49% in the quarter, good for 3% of revenue growth and helped fuel 22% DTC growth -- implying that Nike’s wholesale orders were up just 3.4%. This is at the same time that inventories in the channel – FL and FINL are getting better on the margin. This is opposite to what we’ve seen historically  -- as the model has been ‘as goes Nike, so goes FL.’ That’s no longer the case. Nike is likely to go down to 70% inside of FL (from 72% last year) and should be closer to 60% within 18 months. This is by design. The datapoints that float around the hedge fund community (Nike losing share) will be extrapolated to the global business – which is simply inaccurate. That’s our biggest concern here – the multiple and certainly NOT the earnings.

 

Here are some other trends we’d point out as notable.

 

1) Nike’s DTC business grew at a staggering 49% this quarter. By our math, US DTC was up over 20% in the quarter, while wholesale was flat. Though the numbers don’t outwardly show it, that’s a sequential improvement from 4Q when wholesale in the US was down 6%. We’re hard pressed to think that wholesale will consistently grow better than 3% in the US ever again. On a trendline basis (out to the TAIL duration) we think that 90% of incremental profit for Nike in the US will come from its DTC/online business.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 9 27 2016 NKE wholesale dtc spread

 

Looked at a slightly different way, we’re down to about 1/3 of incremental revenue growth coming from wholesale – 50% lower than just two years ago. The spread is much greater on the gross profit line as DTC carries 3-4x gross profit dollars as wholesale.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 9 27 2016  NKE distro channels

 

2) Futures/Revenue Delta: There’s been a 5-7 point delta between Futures growth and reported revenue growth in the past four quarters. Therefore the trends we saw today are actually not unusual. Campion’s assertion that we should see revenue growth ahead of futures growth throughout 2017 is actually plausible.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 9 27 2016 NKE ecomm vs futures growth

 

3) But…can anyone explain the moving target that is Nike Futures? The company has tweaked/changed its disclosure in each of the past four quarters. Yeah…we get it that futures are largely unaudited, and should not matter as much as the wholesale model shrinks relative to the whole. But for a World Class company like Nike, we expect World Class disclosure. #fail.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 9 27 2016 NKE futures disclosure

 

4) GM/Inv/Futures: If there is only one chart we need to see for Nike – after e-comm growth – it is the triangulation in futures, inventory and gross margins. The two former almost always are a great predictor for the latter.  This quarter, however there was a big disconnect – not the least of which was the (uncharacteristically opaque) reclass of expenses from SG&A to COGS. By our math, this dinged GM% by about 100bp. On an adjusted basis, we should see GM accelerate throughout this year as mix shifts higher and DTC is increasingly consolidated.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 9 27 2016 NKE gm v futures inventory spread

 

5) SIGMA Improved. This might look gnarly – and it does. But the fact is that inventories corrected – slightly – on the margin. And everything matters on the margin. The next move is likely to be in the upper left, which is multiple-positive.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - NKE SIGMA

 

 

Below is our previous note from 9/26/16:

 

NKE | Key Issues – And What To Expect

Not a slam dunk qtr.  But the bear case is just too easy to build – so everybody’s doing it.  It’s lacking context and in some cases, truth.

 

Let’s be clear about one thing…we’re definitely nervous about Nike’s 1Q print. This has not been a battleground stock for the better part of three years – but today there is no question that it is. In fact, a short-seller’s narrative around this name has never been easier to construct – at least in this economic (and sneaker) cycle. It sounds something like this…

  • Sharply decelerating futures trends in last quarter,
  • Simply massive acceleration in the Adidas brand,
  • Continued growth out of UnderArmour,
  • Shrinking US distribution,
  • NKE already tapped out inside FL (72% of FL sales bear a Swoosh),
  • The Olympic Hangover,
  • Golf Implosion,
  • Peaky valuation, and
  • Hockey Stick Guidance

But the simple fact, and it is a fact, that it is so easy to construct this bear case leaves us more inclined to think that it has become the consensus. In addition, while many of these ‘fear factors’ are concerning, we think that easily half of them are being blown out of proportion and lacks the context for a behemoth that manufactures 285mm pairs of kicks a year.

 

Our sense is that given the pessimism around the name, if you think Nike can

a) Nike can hit the quarter (TRADE), and

b) Deliver on the hockey stick (TREND),

 

And you think that these TAIL factors will come to fruition…

a) Gross margins headed above 50%, and

b) $5.00+ in EPS power just below the surface with sharply accelerating returns and the management team to unleash it.

…then this is probably a stock you want to own.

 

We vet through all these factors in our 45-page Black Book which we presented earlier today. Here’s the video link.

Replay: Nike: Key Issues Ahead of the Print

 

We hand-picked some of the slides that garnered the most interest. Here goes…

 

1. EPS Trajectory. We believe in the ’hockey stock’ EPS trajectory for FY17 (May). Post-Olympic product flow is strong and DTC accelerates on top of lower SG&A. Then e-comm drives the top line and gross margin line for the duration of the model. All in, we get near $5 in EPS in 3-4 years, which is 30% above the consensus.

 

2. Adidas’ Momentum matters. The ‘Yeezy’ really does not. We only bring up the Kanye shoe bc we are asked about it so often. To put it into context, Jordan is a $6.3bn brand at retail. If Yeezy triples this year, it will be $300mm. At best we’re talking 70bps in share. Not relevant.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 2B 9 26 2016 YEEZY

 

3. What does matter is the core Adidas share gain, which is very real. But let’s remember where Adidas is coming from – hint: a very low base. Before the AdiBok merger in 2005, the two brands had 16pts combined share. By 2014 the company evaporated its share to 6%. Reebok has all but gone away. Can Adidas recapture 2-3 points? Yes. Does that mean it comes out of Nike’s coffers? No. Yes this is a zero sum game. But NKE, Adi and UA can all gain a point of share for the forseeable future without stepping on each other’s kicks.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 3B 9 26 2016 adibok bar

 

4. Content Winning, Distribution Losing. Adidas’ web traffic is en fuego. But Nike isn’t doing too bad either. We’re seeing steady losses, actually, in traditional Brick&Mortar channels. Beware Foot Locker.  This trend will be more sever and will last longer than most people think.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 4B 9 26 2016 9 38 35 PM

 

5. Nike hates this. This chart shows age vs income for the Nike and Adidas demo. Simply put, the Nike consumer is getting older, while the Adidas consumer is younger and richer. This fuels that ‘your father’s Buick’ argument for Nike. That said, if there is any one factor Nike is aware of internally, it is this one. The risk is not that the brand gets too old, it is how much money Nike will spend (and it will spend what is necessary) to keep it youthful and awesome.  

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 5B 9 26 2016 cust dem

 

6. e-comm targets are beatable. We get a lot of pushback on Nike’s $7bn e-comm target by ’19. We think the internal target is $8-9bn. Our estimate is $9-11bn. Two points here. A) Nike hitting its goal only represents a 30% CAGR. There’s nothing outrageous about this – 20% in US and 40-50% int’l. If we see 40% we get to $8.5bn, and 50% = $12.5bn. Nike will hit these not just through product innovation, but by manufacturing/distribution innovation – that’s the factor people are not banking on. This is already in the pipe for Nike – they’re simply not talking about it.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 6B nke6

 

7. With great e-comm growth comes great channel conflict. Remember in 2002/3 when Nike and Foot Locker tried to figure out whether content or distribution was more relevant. Hint, Nike won. But during that time, Nike’s stock was off by 22% relative to the market.  We’re about 9 months into the start of a channel conflict 14 years later, and year-to-date NKE is down – yes you guessed it – 22% relative to the market. We’re not calling this a template, but are simply making the point that there’s a lot of bad news in this stock.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 7B nke7

 

8. THE KEY SLIDE NO ONE TALKS ABOUT. With Nike consolidating incremental units in a vertical model (i.e. in its own DTC business) there is a natural revenue lift that’s underappreciated. In other words, with no change in end market share, Nike goes from consolidating $65 for a $140 shoe that sells through wholesale to booking all of a $175 shoe online. This is about a 2,000bp margin lift, and more importantly accounts for 3-4x the gross profit dollars. Looking at the right half of the slide below…

a. Assuming the market does NOT grow one bit, and Nike’s share is unchanged, we’ll see 60bps revenue growth simply from the consolidated accounting. In this scenario, our numbers are too high. Unlikely.

b. In the second scenario, where the market grows at 4% and Nike share change is ZERO, we’ll see 4.7% growth in consolidated revenue – halfway to the company’s hsd goal. This should be easy.

c. With the market growing by 4% and Nike gaining 1 point of share, we get to 9.8% top line growth – which more than puts Nike over its long term goal. In other words, hitting its long term goals are easier than Nike has experienced in recent years.   

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 8B nke8

 

9. Inventories are still questionable. Nike’s SIGMA is in a rough place – Quad 3 is never good. We’re also seeing unusual discounting in Nike’s in-line stores, where the company is going in with heavy price points, but is offering up 20% off cards when you walk in the store. Our sense is that the SIGMA will turn up this quarter – something that has to happen for the stock to work.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 9B

 

10. GLOBAL SIGMAs. This is more of an fyi…but we have enough disclosure to calculate SIGMAs in every region. They all pretty much look bad – except Emerging Markets. The US, at a minimum, should improve, as noted above.   

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 10B 9 26 2016 SIGMA INTL 2

 

11. Another Key Chart. If I could look at only chart every quarter, this would be it. It triangulates futures, inventories and gross margins. When Futures are trending up, inventories are trending down, it invariably leads to extremely bullish gross margins. Today, we have decelerating futures and bloated inventories. That should be bad. BUT, we think we’ll see solid GM trends out of Nike – which is not to say that core margins are good. But simply that the e-comm benefit is more than offsetting weakness in merchandise margins. That’s a secular trend, and a bullish on eat that. Even more so when inventories are completely clean.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 11B nke11

 

12. Olympic Trade Does Not Exist. People always talk about the ‘Olympic Trade’ with the understanding that you should own Nike 3-6 months into the Olympics. Never has this proven to be the case. Back to 1992 when we separated the Summer and Winter games into 2-year increments, there has been only one out of seven Olympic Games where this trade worked. In fact, the stock more often works after the games. Why? The channel gets cleaned out just ahead of the Games, revenue is strong due to the product launched around the event, and lastly, SG&A rolls over resulting in a fat hockey stick in EPS (usually more than people think).

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 12B 9 26 2016 OLYMPIC NEW

 

13. Futures Transparency. Here’s a nit pick – but a valid one at that. Nike has slowly evolved its verbiage around Futures over the past year. First it said, as it always did, that Futures excluded DTC. Then in 3Q16 Nike started getting vague about how futures are accounted. Then in 4Q Nike said “consistent with prior periods, futures include [DTC including e-comm]. This actually matches up with economic reality, so we can’t really fault Nike. But this is hardy the stand-up disclosure we’ve grown to expect from this company.

NKE | Fundamentals Save CFO’s ‘Own Goal’ - 13B nke13


Know Your Lease Accounting (And Which Companies Change It Without You Knowing)

Takeaway: Next time in a 1-1 w/ a CFO, ask about the company’s trends in lease terms. All competitive ammo we’ll ever need in having those discussions

Here’s something that consistently flies under the radar in almost every conversation we have with investors. This is an analysis that shows the underlying lease profile for every company in the retail supply chain that we follow (about 180 of them). If you’re signed up for our RetailDirect product, the full 180-page deck should appear in your inbox shortly. With this analysis we can see how the underlying lease profile is changing for retail. The punchline is the we’re seeing lease terms stretch to a level we have not seen since the end of the last economic cycle. While not toxic, this is definitely a level that suggests to us that the group is either a) unit growth starved, or b) in search of margin – by stretching out the duration of its lease portfolio. There’s puts and takes by company – but the overall trend is clear, and it has earnings implications.

 

What does it mean to ‘stretch out the duration’?

First off, let’s calculate said ‘duration’. It really comes down to the ratio of rent minimums carried off balance sheet that are required to be paid over the next 1-2 years compared to what a company is obligated to be pay 5+ years out. Let’s not get too focused on the periods used, as the trajectory will be roughly the same for a given company regardless of the period in question.

For the retail industry as a whole –we have a weighted average duration of 7 years. That’s meaningless on its own. We have to look at this relative to itself, which has shown an upward (negative) rate of change since the Great Recession. It might not sound like much, but look at the chart below. 

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart1

 

What Does It Mean When The Duration is Headed Higher?

Basically, it means a company is signing leases it largely cannot afford. To avoid losing the property to a competitor, it is either…

a) Buying Into Escalating Rent Trajectory.  This means signing leases with low initial payments, but high (usually dd) rent escalators in the outer years. That way it can book revenue, low rent costs, and worry about paying ‘real’ market rents sometime down the road. This is akin to a family that makes $90,000 a year, and takes out an interest-only 5-yr arm in order to buy that $2mm ‘dream home’ (that probably needs work) in Summit NJ.

b) Buying Time. This basically means signing a lease years before the competition would even consider it. Usually a company will sign about 2-years out from the property open date. 3-years max. But sometimes we’ll see ‘growth’ retailers without the cash flow to compete for premium properties sign up for a property that’s not available for another 4-5 years. It’s pretty arrogant that any company – even the best retailer around – can predict which plot will be relevant more than one Presidential term down the road. Importantly, there’s no way of knowing who the co-tenants will be. So while you think you’re moving next to a Restoration Hardware or Tiffany, you end up next to Olli’s Bargain Basement or Hibbett Sports. This ‘risk’ manifests itself in a growing duration – and while it is a hypothetical number, it represents margin risk that is very real sometime in the not-too distant future.

Check out  CRI, FL, KSS, TGT, BURL, KATE, etc… The list goes on.

 

What Happens For Those Companies Where The Lease Duration is Headed Lower?

Simply put, reverse all the negatives I just called out. A lower lease portfolio duration means that…

a) Pay More Today, Owe Less Tomorrow. That means long term liabilities come down, and current payments go up. Most would call this bearish as it relates to hitting estimates. But when a management team opts to pay more over the near-term instead of being up against a wall in 3-5 years, we call that proactive risk management. That’s akin to paying off high interest debt, or taking a 30-year fixed mortgage to a 15-year loan – higher payments, but lower interest cost, and lower long-term risk. Check out RL and BKS.

b) One point worth noting is that this would also happen to a company that has just run out of growth or is closing stores with longer-dated durations. Acquisitions can just as easily skew these numbers one way or another.

 

COMPANY CALLOUTS

Here’s an overview of the implied duration by retailer. One obvious pattern is that the specialty mall-based retailers hover between 5-6 years, while the department stores are almost all twice that level. Of particular note is Target at 20 years, and Kohl’s is 23 years! Let’s be clear about this…KSS is managing its liability profile in a way that assumes it is still actually selling product in its stores in another 20 years. We’d take the ‘under’ on that one.

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart2

 

RL (Bullish): Props to RL – a big liquid name that no one cares about today. The company is definitely doing the right thing as it refocuses on it’s real estate portfolio. Seeing this makes incrementally more positive on RL (which is on our Long list already).

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart3

 

BKS: Here’s an example of a bullish trend. As BKS becomes increasing obsolete, the management team has jettisoned or restructured property agreements such that lease duration has come down by 50% -- offering greater flexibility as it faces more AMZN/Online competition.

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart4

 

FL: BEARISH. Property age is not egregious, and is lengthened by Int’l stores. But numbers are numbers – they don’t lie. At a time when 72% of its revenue (Nike) will generate 100% of incremental gross profit online over 5 years – this real estate trend is simply not good.

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart5

 

DG: BEARISH. Should a dollar store really be stretching out its lease duration as it adds more marginal locations in an increasingly competitive space? Probably not. This is near-term bullish (lowering rent minimums) but taking up long-term liabilities.

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart6

 

CRI: BEARISH. Same thing. Carters moved into Canada and is increasingly competing in the playwear market (ie competes w everyone from Old Navy to Nike). Still a killer infant brand. But beyond that we’re concerned.

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart7

 

KATE: BEARISH. We generally are positively predisposed to KATE – and think it will be bought by YE17. The the buyer better take note of how the lease duration has changed since this became a ‘Kate-Only’ company.

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart8

 

BURL: BEARISH. Not a name we’ve trafficked in historically. But if you own this name, this chart shows a bad trend management better have an answer to.

Know Your Lease Accounting (And Which Companies Change It Without You Knowing) - 9 27 2016 chart9


Bed, Bath & Beware (and WSM, KSS, etc...)-- Wayfair Wedding Registry

Takeaway: This Wayfair wedding registry is not just a meaningless PR move. It is real, and it is likely to be impactful to the B&M incumbents.

Wayfair's New Wedding Registry Is Likely To Pose A Big Threat To B&M

  • This is such a no-brainer that we actually though Wayfair already had one.
  • We actually think that this should be an incremental comp driver for W, which probably flies in the face of our bear case.
  • But what it certainly does is pressure the incumbent brick & mortar retailers – like Bed, Bath & Beyond, which we estimate generates 5-10% of sales from its registry.
  • Check out the chart below, this is the online overlap in customers shopping online at Bed Bath and Wayfair. We’ve seen 1,000 points of incremental pressure at BBBY over just 16 months, which is the fastest rate we’ve ever seen any retailer get disintermediated.
  • This synchs with BBBY management’s somewhat aimless commentary on the conference call about how it losing share.
  • The problem for BBBY and KSS, M, WSM (especially Williams-Sonoma and Pottery Barn) is that we could see the W overlap chart below go to 50%, 60%, even 70%. Keep in mind that Wayfair’s brand awareness has moved up to 75%.
  • Definitely a development to watch.

 Bed, Bath & Beware (and WSM, KSS, etc...)-- Wayfair Wedding Registry - bbbyw


NKE | Key Issues – And What To Expect

Takeaway: Not a slam dunk qtr. But the bear case is just too easy to build – so everybody’s doing it. It’s lacking context and in some cases, truth.

Let’s be clear about one thing…we’re definitely nervous about Nike’s 1Q print. This has not been a battleground stock for the better part of three years – but today there is no question that it is. In fact, a short-seller’s narrative around this name has never been easier to construct – at least in this economic (and sneaker) cycle. It sounds something like this…

  • Sharply decelerating futures trends in last quarter,
  • Simply massive acceleration in the Adidas brand,
  • Continued growth out of UnderArmour,
  • Shrinking US distribution,
  • NKE already tapped out inside FL (72% of FL sales bear a Swoosh),
  • The Olympic Hangover,
  • Golf Implosion,
  • Peaky valuation, and
  • Hockey Stick Guidance

But the simple fact, and it is a fact, that it is so easy to construct this bear case leaves us more inclined to think that it has become the consensus. In addition, while many of these ‘fear factors’ are concerning, we think that easily half of them are being blown out of proportion and lacks the context for a behemoth that manufactures 285mm pairs of kicks a year.

 

Our sense is that given the pessimism around the name, if you think Nike can

a) Nike can hit the quarter (TRADE), and

b) Deliver on the hockey stick (TREND),

 

And you think that these TAIL factors will come to fruition…

a) Gross margins headed above 50%, and

b) $5.00+ in EPS power just below the surface with sharply accelerating returns and the management team to unleash it.

…then this is probably a stock you want to own.

 

We vet through all these factors in our 45-page Black Book which we presented earlier today. Here’s the video link.

Replay: Nike: Key Issues Ahead of the Print

 

We hand-picked some of the slides that garnered the most interest. Here goes…

 

1. EPS Trajectory. We believe in the ’hockey stock’ EPS trajectory for FY17 (May). Post-Olympic product flow is strong and DTC accelerates on top of lower SG&A. Then e-comm drives the top line and gross margin line for the duration of the model. All in, we get near $5 in EPS in 3-4 years, which is 30% above the consensus.

NKE | Key Issues – And What To Expect - 9 26 2016 FINANCIALS

 

2. Adidas’ Momentum matters. The ‘Yeezy’ really does not. We only bring up the Kanye shoe bc we are asked about it so often. To put it into context, Jordan is a $6.3bn brand at retail. If Yeezy triples this year, it will be $300mm. At best we’re talking 70bps in share. Not relevant.

NKE | Key Issues – And What To Expect - 9 26 2016 YEEZY

 

3. What does matter is the core Adidas share gain, which is very real. But let’s remember where Adidas is coming from – hint: a very low base. Before the AdiBok merger in 2005, the two brands had 16pts combined share. By 2014 the company evaporated its share to 6%. Reebok has all but gone away. Can Adidas recapture 2-3 points? Yes. Does that mean it comes out of Nike’s coffers? No. Yes this is a zero sum game. But NKE, Adi and UA can all gain a point of share for the forseeable future without stepping on each other’s kicks.

NKE | Key Issues – And What To Expect - 9 26 2016 adibok bar

 

4. Content Winning, Distribution Losing. Adidas’ web traffic is en fuego. But Nike isn’t doing too bad either. We’re seeing steady losses, actually, in traditional Brick&Mortar channels. Beware Foot Locker.  This trend will be more sever and will last longer than most people think.

NKE | Key Issues – And What To Expect - 9 26 2016 9 38 35 PM

 

5. Nike hates this. This chart shows age vs income for the Nike and Adidas demo. Simply put, the Nike consumer is getting older, while the Adidas consumer is younger and richer. This fuels that ‘your father’s Buick’ argument for Nike. That said, if there is any one factor Nike is aware of internally, it is this one. The risk is not that the brand gets too old, it is how much money Nike will spend (and it will spend what is necessary) to keep it youthful and awesome.  

NKE | Key Issues – And What To Expect - 9 26 2016 cust dem

 

6. e-comm targets are beatable. We get a lot of pushback on Nike’s $7bn e-comm target by ’19. We think the internal target is $8-9bn. Our estimate is $9-11bn. Two points here. A) Nike hitting its goal only represents a 30% CAGR. There’s nothing outrageous about this – 20% in US and 40-50% int’l. If we see 40% we get to $8.5bn, and 50% = $12.5bn. Nike will hit these not just through product innovation, but by manufacturing/distribution innovation – that’s the factor people are not banking on. This is already in the pipe for Nike – they’re simply not talking about it.

NKE | Key Issues – And What To Expect - nke6

 

7. With great e-comm growth comes great channel conflict. Remember in 2002/3 when Nike and Foot Locker tried to figure out whether content or distribution was more relevant. Hint, Nike won. But during that time, Nike’s stock was off by 22% relative to the market.  We’re about 9 months into the start of a channel conflict 14 years later, and year-to-date NKE is down – yes you guessed it – 22% relative to the market. We’re not calling this a template, but are simply making the point that there’s a lot of bad news in this stock.

NKE | Key Issues – And What To Expect - nke7

 

8. THE KEY SLIDE NO ONE TALKS ABOUT. With Nike consolidating incremental units in a vertical model (i.e. in its own DTC business) there is a natural revenue lift that’s underappreciated. In other words, with no change in end market share, Nike goes from consolidating $65 for a $140 shoe that sells through wholesale to booking all of a $175 shoe online. This is about a 2,000bp margin lift, and more importantly accounts for 3-4x the gross profit dollars. Looking at the right half of the slide below…

a. Assuming the market does NOT grow one bit, and Nike’s share is unchanged, we’ll see 60bps revenue growth simply from the consolidated accounting. In this scenario, our numbers are too high. Unlikely.

b. In the second scenario, where the market grows at 4% and Nike share change is ZERO, we’ll see 4.7% growth in consolidated revenue – halfway to the company’s hsd goal. This should be easy.

c. With the market growing by 4% and Nike gaining 1 point of share, we get to 9.8% top line growth – which more than puts Nike over its long term goal. In other words, hitting its long term goals are easier than Nike has experienced in recent years.   

NKE | Key Issues – And What To Expect - nke8

 

9. Inventories are still questionable. Nike’s SIGMA is in a rough place – Quad 3 is never good. We’re also seeing unusual discounting in Nike’s in-line stores, where the company is going in with heavy price points, but is offering up 20% off cards when you walk in the store. Our sense is that the SIGMA will turn up this quarter – something that has to happen for the stock to work.

NKE | Key Issues – And What To Expect - nke9

 

10. GLOBAL SIGMAs. This is more of an fyi…but we have enough disclosure to calculate SIGMAs in every region. They all pretty much look bad – except Emerging Markets. The US, at a minimum, should improve, as noted above.   

NKE | Key Issues – And What To Expect - 9 26 2016 SIGMA INTL 2

 

11. Another Key Chart. If I could look at only chart every quarter, this would be it. It triangulates futures, inventories and gross margins. When Futures are trending up, inventories are trending down, it invariably leads to extremely bullish gross margins. Today, we have decelerating futures and bloated inventories. That should be bad. BUT, we think we’ll see solid GM trends out of Nike – which is not to say that core margins are good. But simply that the e-comm benefit is more than offsetting weakness in merchandise margins. That’s a secular trend, and a bullish on eat that. Even more so when inventories are completely clean.

NKE | Key Issues – And What To Expect - 9 26 2016 fitures

 

12. Olympic Trade Does Not Exist. People always talk about the ‘Olympic Trade’ with the understanding that you should own Nike 3-6 months into the Olympics. Never has this proven to be the case. Back to 1992 when we separated the Summer and Winter games into 2-year increments, there has been only one out of seven Olympic Games where this trade worked. In fact, the stock more often works after the games. Why? The channel gets cleaned out just ahead of the Games, revenue is strong due to the product launched around the event, and lastly, SG&A rolls over resulting in a fat hockey stick in EPS (usually more than people think).

NKE | Key Issues – And What To Expect - 9 26 2016 OLYMPIC NEW

 

13. Futures Transparency. Here’s a nit pick – but a valid one at that. Nike has slowly evolved its verbiage around Futures over the past year. First it said, as it always did, that Futures excluded DTC. Then in 3Q16 Nike started getting vague about how futures are accounted. Then in 4Q Nike said “consistent with prior periods, futures include [DTC including e-comm]. This actually matches up with economic reality, so we can’t really fault Nike. But this is hardy the stand-up disclosure we’ve grown to expect from this company.

NKE | Key Issues – And What To Expect - nke13


NKE | Officially A Battleground Stock

Takeaway: We're hosting a call on Monday, Sep 26 at 1PM ET to review the key issues/investor concerns heading into the Q. Expect some fireworks.

For the first time in years, we'd call Nike a "battleground stock' headed into the print.

 

Given sharply decelerating futures trends, simply massive acceleration in the Adidas brand, continued growth out of UnderArmour, shrinking US distribution, NKE already tapped out inside FL (72% of FL sales bear a Swoosh), the Olympic Hangover, a peaky valuation, and guidance that implies a steep hockey stick in the back half -- it is easy as ever for a short-seller to build up a juicy case as to why this name is headed lower.

 

Our sense is that given the pesimism around the name, if you think a) Nike can hit the quarter, b) deliver on the hockey stick, c) think gross margins are headed above 50%, and d) see $5.00+ in EPS power, this is probably a stock you want to own.

 

We're going to review all these concerns, hit on a few others we have our eye on, look at where the increasingly bearish consensus is right, and where it is likely to get burned.

 

Call Details:

Toll Free:

Toll:

UK: 0

Confirmation Number: 13645633

 

Live Video Link: CLICK HERE

Materials Link: CLICK HERE

 


EVENT | Nike: Key Issues Ahead of the Print

Monday, September 26th at 1:00PM ET

Watch a replay below.

CLICK HERE to access the associated slides.

CLICK HERE to acces the audio-only replay. 

 


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