NIKE: The 3-Peat

The sentiment, calendar, and consensus nature of the average Buy rating does not lead us to be particularly bullish into the print. But at some point over the next 2-quarters, there’s likely to be some form of exodus of people who rented the stock that will allow those with a long duration to capitalize on the REAL call, which is that 2013 and 2014 will be a 3-peat.

 

The Punchline here is that if you were to ask the average analyst what they think about Nike today, they’ll say ‘Buy it because A) the order book is both solid and strengthening, B) while revenue builds, NKE starts to anniversary cost pressures from a year ago, and C) the impacts of price increases start to take effect. In addition, there’s the sentiment associated with an extremely robust event calendar with 1) UEFA European Football Championship (note to Americans – Europeans think that this is like the World Cup excluding Brazil), 2) The Olympics in London, and 3) Nike taking over the NFL license as the new season kicks off in the summer.

 

All this makes for a great momentum story. That’s why the stock is up 22.7% year to date – more than 3x the S&P.

 

So now what?

 

Will the company have a great quarter? Yes. They will. We think that they’ll beat the $1.16 consensus by at least a dime. Then it’s off to the races as it relates to event flow.

But mark my words, there will be some event by August that will prompt momentum money to peel off this trade – even if that event is time itself. Most momentum investors probably know that, and will therefore look to do it sooner rather than later.  We’ll never fault anyone for booking a gain. So hats off to them. 

 

But at the same time, this creates an opportunity for people that have wanted to invest in the company but have seen the stock zip past them faster than LeBron James on a breakaway dunk.

 

Our point is that the company has invested so heavily in its consumer alignment, product innovation, and sales distribution organizations over the past three years, which we think has resulted in competitive positioning that is worlds ahead of any traditional competitors. This means that while momentum traders will be concerned that ‘comps will be tough and growth will roll’ next year, the reality is that Nike is going to repeat CY2012 again, and then again.

 

This was best evidenced at Nike’s recent innovation summit in NYC, which we had the pleasure of attending. The degree to which Nike has elevated the playing field is simply jaw-dropping. To be clear, we’re not talking about simply making updates to existing product platforms, or aligning apparel better with footwear. Those things are nice, but the updates don’t drive sales, they maintain them. Better product alignment is a productivity booster, and good for a couple of growth points in sales. But is not revolutionary.  Nike simply does not borrow R&D and marketing dollars from one side of the organization and give it to another. That’s called ‘pissing off your employees and not growing revenue.’

 

Nike, rather, has invested in new platforms like FlyNet. We can’t do it much justice here, but the picture below shows a glimpse of the new line – which will hit stores in July. It is a combination of ‘lean and green manufacturing’ with new materials and an extremely commercial new design to make one of the lightest running shoes ever made. (Note: for those of us who are more sedentary, the average runner has around 14,000 heelstrikes per hour. You think that a few ounces per shoe does not matter? Do the math…).  This can be as big or bigger than NikeFree (which will still grow when FlyNet launches).

 

NIKE: The 3-Peat  - NKE flynet

Source: Nike Innovation Summit

 

Another game-changer – pardon the pun – is the Nike+ Fuelband.  Most people know about Nike+, and how the chip in Nike shoes can synch up with your iPod to collect training data and share electronically with friends and coaches. We also all know that about a week after that came out, running shops were selling little pouches for $3 that allowed you to put the chip on any other brand of shoe you wanted. 

But the evolution of this technology is astounding.

One major change is that while there is still a chip, it feeds off several weightless electronic sensors built into the sole of the shoe. No Nike shoe, no Nike+.

More importantly, they rolled this out to basketball and training, and made it far more digitally integrated. Simply put, they’ve taken the concept of ‘going digital’ beyond any consumer brand aside from Apple. Now you can download a workout schedule for dozens of different athletes across many sports, and literally train with and compete against them (and your friends). The technology tracks vertical lift, speed, cadence, lateral movement, acceleration, and even ‘lazy time’ (time you spend sitting idle during a game).

And yes, the technology is attached to shoes ranging from $90 to $160.

 

As it relates to how the 3-Peat theme plays out in our model, we get to EPS estimates that are nearly a buck higher than consensus for each of the next two years.

That’s about 20% annual EPS growth for the top player in a global growth space with extremely difficult barriers to entry, and a structural advantage from a sourcing/selling perspective as China gains share of the world economy. It has a consistent track record for executing operationally, making the right human and financial capital deployment decisions, and overdelivering on expectations. Tack on $8 per share in net cash, and enough annual free cash flow to comfortably buy back 5% of its current market cap per year, and this is a pretty good place to be.

Does it look expensive on the consensus numbers (19.5x forward estimates?). Yes.

But on our numbers, we’re looking at a multiple closer to 16x earnings and 10x EBITDA. We’re cool with that.

 

NEAR-TERM CONSIDERATIONS

This is where TRADE considerations matter.

As noted the consensus is for a bullish momentum trade.

The ‘buy ratio’ is right in line with where it’s been for 2-years – but the actual upside to sell side price targets is only 2%. That’s the lowest it’s been in at least 3-years. 

 

NIKE: The 3-Peat  - NKE buy ratio

Source: Bloomberg 

 

Also, the ‘short interest ratio’ numbers reported by most data providers are a bit misleading. It suggests a ratio near three-year peaks. But the reality is that we’re only looking at 0.9% of the float short the stock – that’s at a trough. The short interest ratio is high simply because volume is at its historical trough. Volume = conviction. The buying audience here is feeling thin to us. 

 

NIKE: The 3-Peat  - NKE short interest

Source: Bloomberg 

 

One last factor to consider about Nike is how and when it sets expectations. We’re sitting here today at the exact time of year when Nike is preparing its budget for FY13. The company has its own unique biorhythm where any negativity that could come out tends to happen around this time of year. A large part of compensation for General Managers is delivering on expectations – or should we say OVERdelivering on expectations. This is when teams at Nike are probably submitting more conservative plans than they really think that they can achieve. That’s pretty apparent in looking at the company’s guidance history.

 

While Nike does not ‘guide’ officially, it gives enough pieces of the puzzle for analysts to do their job. What happens more often than not is that Nike takes down estimates – thinking that they’re being realistic – but they end up coming in ahead of where estimates were in the first place before they lowered guidance. Sounds confusing, but hopefully the chart below illustrates it. 

 

NIKE: The 3-Peat  - NKE expectations vs reality

Source: Factset

 

The Punchline is that the sentiment, and time of year does not lead us to be particularly bullish into the print. But at some point over the next 2-quarters, there’s likely to be some form of exodus of people who rented the stock that will allow those with a long duration to capitalize on the REAL call, which is that 2013 and 2014 will be a 3-peat.

 

NIKE: The 3-Peat  - Nke SIGMA

 

Brian P. McGough
Managing Director

 

 

 


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