Here’s our view on NKE into the quarter. While we have them coming in above consensus, it matters little to our positive longer-term TREND call on the name. Here’s a small excerpt from our Nike Black Book showing our TRADE duration:
TRADE: We like Nike's earnings into the quarter -- though in today's tape, we're not quite sure if that matters. We’re modeling $1.30 vs. the Street at $1.21. We’re somewhat aggressive on the gross margin line with a decline of -250bps relative to guidance of -300bps (and the Street at -290bps) as we think that Nike’s inventory is particularly clean at retail, and pricing strategies have gotten off to a good start at retail. Also, we have Demand Creation down 8% vs. last year as Nike anniversaries the remnants of World Cup, and saves its Demand Creation dollars for the back half of the year. We’re likely looking at another quarter of heavy inventory investment – as seen over the past two quarters. But then starting in the November quarter, we start to see increasingly easy comps on the balance sheet (and subsequently the margin line on the P&L).
Our call on Nike goes far beyond the quarter…
We think that investors are underestimating both the depth and duration that Nike’s recent infrastructure investments will have on financial results. It is one of the few companies that fits within our three different durations – TRADE (3 weeks or less), TREND (3 months or more) and TAIL (3 years or less). We like it at current levels, and think that there is upside to earnings in the coming quarter, the remainder of the May 12 year, and throughout the next three years. If Nike puts a lid on guidance on Thursday, as its biorhythm so often leads it to do with 1Q earnings, then we think it will be a great shot to get involved.
True, with a current EBITDA multiple of 10x our F12 estimates, Nike might not look like the cheapest name out there. But we think that earnings and cash flow expectations are too low across all durations, and that Nike has such a commanding lead right now in a global duopoly backed by the tools to sustain it. Combine that with a bullet proof balance sheet and what we think is a permanent structural advantage in sourcing product in a strengthening Yuan climate and this story has some serious legs to stand on.
We issued our first Nike Black Book on March 1stof last year, as we thought that the multi-year restructuring at Nike would start a reacceleration in sales, earnings, and returns. We think that played out pretty well over the ensuing year. While the stock has continued to outperform on the margin, there’s definitely been more concern creeping back into the consensus as to the sustainability of business trends, reliance on a so-called ‘sneaker cycle,’ and the direction of earnings growth in a global economic climate that most would agree is treacherous at best.
Why? People tend to focus on ‘comping the comp’ with futures – as they do most retail growth metrics. For your average company – one that gets lucky on a trend, a specific business initiative, or the economy – that’s a fair thing to keep in mind.
While we can’t completely ignore that with Nike, we need to respect its proactive approach to creating its own destiny, and it’s proven track record of a) investing capital in new business initiatives and taking share, b) realizing when it’s time to change its organization in order to adapt to a changing marketplace, and c) making the right changes to facilitate its next leg of growth – even if unpopular with shorter-term investors.
While its investments have been well telegraphed, the results have not. Yes, we’ve seen an acceleration in futures trends, but the depth, breadth and duration of the company’s product and distribution pipe is still far from understood (by Wall Street and competitors alike).
The company was in what we’ll call ‘restructuring mode’ for the better part of two years. If you look at Nike historically, you’ll see that its payback vs. restructuring was 2-3x as measured by time. Similarly, cash on cash returns on incremental capital averaged better than 20%.
There’s no reason why this won’t hold true this time around, and in fact should generate return on assets starting with a 3. which suggests to us that Nike will, in fact, add another $7-$8Bn in revenue over the next 3-4 years.
This is not just blind faith on our part. We’re already seeing it in several areas – including three critical areas we outlined in our last Black Book that needed to be addressed, a) Apparel, b) Retail, and c) Women. This represents a critical power base inside the company that is just starting what we think will be a continued key driver to Nike’s business over time.