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NKE: How We’d Play It


Today’s sell-off in Nike is a great example of the volatililty we should continue to see in the name for the next two months. The cards are stacked against it near-term, which is a gift for someone who wants to respect this thing we call earnings power.


From a trading perspective, NKE is bearish TRADE and TREND on our models. We rarely make ‘the sentiment trade’ on Nike, and we’re not going to start today. As such, until either a) NKE’s volatility ebbs, b) eight weeks’ time passes, or c) it’s price corrects, we’d rather be long the quality growth in UA, which is bullish TRADE and TREND – the opposite of where Nike is sitting.  


There’s a very real mismatch with why we think the consensus owns Nike, versus why it SHOULD own Nike. The consensus view around Nike has been focused around near-term earnings upside and business momentum around key events and initiatives.

  1. Launch of the NFL deal. But that’s passed. NKE still reaps the benefits – and at an accelerating rate. But the initial splash has come and gone.
  2. Momentum in the North American business. Last quarter was 22% futures growth – the equivalent of adding an UnderArmour, and having $300mm left over.  We can’t imagine that anyone thinks this is sustainable. But still, the rate is going down, not up.
  3. European Football Championships: Americans deny its existence, but this is bigger to Europeans than the Super Bowl and World Series combined. The event is halfway through.
  4. Launch of FlyKnit: Great new product, platform and manufacturing technology for Nike. It hits stores in full within a month. That’s great, but too many people are asking us about it. We don’t like when people get too pumped on a single initiative. Over 2-3 years, it definitely matters. But no single product can make or break this company.    
  5. ‘The Olympic Trade’. We never could justify the rationale behind it. But it exists. No one is buying the stock now based on the event, but unfortunately those that are simply there to rent the stock rather than own the company will need to exit.

We still think that the REAL call is that Nike is going to ‘three-peat’. It’s having a great FY12. That will happen again in FY13, and again in FY14. We think it’s largely top line driven, but we’ll also see a meaningful recovery in Gross Margins due to growth in consumer direct, better pricing power, lower product costs, and fewer close outs due to a more efficient manufacturing process.


If we could craft this perfectly, it would be for long investors to wait for the ‘freak out’ event sometime over the next 8 weeks. If it doesn’t happen, then it’s probably because the company is giving the Street ammo to take up numbers in the outer years. In that event, we’d be comfortable getting in late – even at or above the current price – as the stock is trading today at less than 13x our May14 estimate. If our $8.00 number is correct, then we’ll be looking at a CAGR of about 20%. What kind of multiple do you put on that kind of growth for a quality global growth story like Nike with 25%+ return on capital? Let’s say it’s a slight discount to its PEG. Maybe 18x? $144 Stock.

 

 


HedgeyeRetail: Key Issue Today. Nike in China


With Li Ning’s preannouncement about high inventories and weak orders, it’s easy to jump to conclusions. But when you quantify one business vs. the other, it opens up the question as to whether Nike is causing Li Ning’s problems, not sharing them.

 

Let’s put some context around Li Ning’s (top local athletic footwear brand in China) preannouncement yesterday, and what the numbers really mean for Nike. The bottom line is that it’s definitely not a positive data point. But in really looking at the size of Nike’s business in China as well as its previously disclosed inventory position, it makes perfect sense that the little guy got crushed. In fact, we’re surprised that we have yet to see the same out of Anta.


Consider the following:

  1. Nike China will clock in about $2.6bn in revenue this year, double that of Li Ning.
  2. Nike, however, leverages that into $900mm of EBIT, compared to $70mm for Li-Ning. Even if we adjust for 15% opex infrastructure given that Li Ning is based in China and Nike carries much of its costs out of the US, it’s still churning out EBIT at 5x the rate of Li Ning.
  3. Nike ended last quarter with 32% growth in inventory. That’s an incremental $820mm yy. This was  heavily weighted to China and Europe. China alone accounted for 13% of Nike inventory growth.

The bottom line is that Nike’s yy growth of $104mm in inventory in China is 1.5x the size of the ENTIRE profit stream generated by Li Ning. Is Nike in the same boat as it relates to Chinese growth slowing? Sure. But a) slowing to the mid-20%s ain’t half bad, and b) we have to consider that Li Ning’s preannouncement was CAUSED BY Nike, instead of being in conjunction with Nike.

 

HedgeyeRetail: Key Issue Today. Nike in China - NKE LiNing

 

 


CHART DU JOUR: IS THIS WHAT RECOVERY LOOKS LIKE?

  • Mature regional gaming markets remain under pressure from new competition, the housing malaise, and an aging customer base.  All of these trends are likely to continue.
  • With four out of the five mature regional gaming states having reported gaming revenue numbers (excluding MS due to flooding), May is looking ugly and SSS could be down 3%
  • February’s pivot turn may be cyclical as gaming has proven to be one of the most economically sensitive consumer sectors

CHART DU JOUR:  IS THIS WHAT RECOVERY LOOKS LIKE? - REGIONAL


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HOUSING: Finally, a solid foundation?

The weekly Mortgage Bankers Association purchase applications numbers are out. It  deals with how many mortgage applications have been filed over a particular week. Hedgeye Financials Sector Head Josh Steiner took note that this week’s print of up 13% was “extremely” strong.

 

HOUSING: Finally, a solid foundation? - mbachart

 

Memorial Day seems to be the catalyst here. The week of Memorial Day is traditionally weak with a negative print, followed by a positive jump in applications the following week. That’s averaged about +6.4% week over week from 2008-2011. This +13% number shows that mortgage application volume is going strong and will continue to do so as we head further into June.

 

The trade here is to be wary of shorting housing. Steiner thinks that shorting housing into the June 27th report for May pending home sales is not the way to go. Looking at the chart above, it’s apparent that something positive is in the works.


FRANCHISING: HEATING UP A DEBATE

We’ve got a conference call for our institutional clients scheduled with President of the Restaurant Finance Monitor and industry expert John Hamburger next Tuesday at 11am ET.  Hedgeye Restaurants Sector Head Howard Penney will be discussing the risks and issues related to heavily franchised business models,  and he will focus on those companies that stand to benefit most from the franchising model.

 

It should be well known at this point that there can be tensions between franchisees and franchisors. That’s to be expected, especially in a period of economic downturn. The weak will eventually get nudged out of the business and the stronger franchisees will wield their power to battle with the franchisor over capital intensive projects like store revamps and new menu items. Ultimately, investors and businesses will suffer when this occurs.

 

In this case, the phrase “keep your eye on the prize” has significant meaning. Sustainable profits and long term goals are important. Prioritizing revenue can cause both parties to compete and when the competition heats up, everyone loses.

 

If you’re a current client or are considering a subscription to Hedgeye, please email sales@hedgeye.com if you’re interested in listening in to the call with Penney and Hamburger.


ARE YOU BULLISH ENOUGH ON KING DOLLAR?: THE SEQUEL

CONCLUSION: Our analysis of derivative positioning and its impact on the FX spot market as a leading indicator strongly suggests that it likely won’t pay to fade consensus as it relates to being bullish on the U.S. Dollar over the intermediate-term TREND. Further, the math supports our fundamental stance of being bearish on things that are inversely correlated to the Greenback over the same duration. The outcome of the JUN 20 FOMC meeting is particularly key to this view.

 

VIRTUAL PORTFOLIO: Long the U.S. Dollar (UUP).

 

On OCT 21, 2011, we published a note titled, “ARE YOU BULLISH ENOUGH ON KING DOLLAR?”; the conclusion of that note is identical to the conclusion above (w/ the exception of the FOMC callout). 

  • Since then, the US Dollar Index is up roughly +7.5% and the 19-commodity CRB Index is down about -13%;
  • Turning to domestic equity markets, the XLE and XLB have underperformed the S&P 500 by -1,271bps and -370bps, respectively over that duration;
  • Turning to global equity markets, the MSCI Energy and MSCI Basic Materials Indices have underperformed the MSCI World Index by -812bps and -745bps, respectively, over that duration;
  • Turning to emerging markets, the MSCI EM Energy and MSCI EM Basic Materials Indices have underperformed the MSCI EM Index by -740bps and -774bps, respectively, over that duration; and
  • The JPM EM FX Index is down roughly -4.3%, with notable currencies like the Brazilian real and the Indian rupee down about -13.7% and -10%, respectively. 

As we often say: “Get the US Dollar right and you’ll get a lot of other things right.”

 

Upon hearing a financial market pundit warn about the overstretched nature of the EUR short position in the speculative community (213k contracts net short is an all-time extreme in either direction), we took an opportunity this morning to refresh our DXY speculative positioning analysis. The results were quite interesting indeed.

 

ARE YOU BULLISH ENOUGH ON KING DOLLAR?: THE SEQUEL - 1

 

Jumping back to the DXY, the following chart highlights the point we just made regarding the “interesting” nature of what is taking place in the non-commercial futures and options markets. Specifically, we’ve just witnessed three consecutive, indistinguishable peaks in the DXY net long positioning – an event that has not yet occurred in the data (since MAR ’95) until the latest reported data point.

 

ARE YOU BULLISH ENOUGH ON KING DOLLAR?: THE SEQUEL - 2

 

In the OCT iteration of this analysis, we found that each peak or trough in the speculative position of the DXY (as measured by futures and options contracts) had a corresponding trough or peak position, as well as a corresponding peak or trough in the US Dollar Index – each on its own lag. Perhaps more  importantly, we found that the move off the bottom in speculative positioning tended to produce an equivalent or greater move off the bottom in the DXY from a standard deviation perspective.

 

ARE YOU BULLISH ENOUGH ON KING DOLLAR?: THE SEQUEL - 3

 

ARE YOU BULLISH ENOUGH ON KING DOLLAR?: THE SEQUEL - 4

 

This really highlights the peculiar nature of having three consecutive extremes in net long positioning, w/ no corresponding extreme in net short positioning. Perhaps more importantly, as the above table highlights, the DXY trough-to-peak move has lagged the trough-to-peak move in speculative positioning by ~1 standard deviation in each of the first two peaks.

 

The key takeaway here is that if that analysis still holds true – particularly the lag between a peak/trough in the speculative positioning and a commensurate peak/trough in the DXY from a standard deviation perspective – we could be looking at higher-highs in the DXY over the intermediate term TREND (see above table for scenario-analyzed timing and magnitude).

 

As we’ve shown in much of our research over the last six months, a narrowing spread between Obama and Romney is fundamentally supportive of this view – particularly as we draw closer to the election because we think that will force the Fed into a political box; as is an escalation of Europe’s Sovereign Debt Dichotomy. Key catalysts on this front include: 

  • JUN 14: Eurogroup Meeting
  • JUN 15: G20 Summit of Finance Ministers
  • JUN 17: Greece – probable date for next general election
  • JUN 18-19: G20 Summit in Los Cabos, Mexico
  • JUN 19-20: FOMC Meeting; Fed releases its revised economic projections***
  • JUN 20-21: Eurogroup Meeting; Ecofin Meeting in Luxembourg
  • JUN 28-29: EU Summit in Brussels, aim to formally sign off on growth proposals; EC meets to discuss Institutional Affairs
  • JUL 5: ECB governing council meeting
  • JUL 11: Minutes from the FOMC’s JUN 19-20 meeting
  • JUL 19: ECB governing council meeting
  • JUL 31-AUG 1: FOMC Meeting*** 

All-told, if consensus doesn’t get what it wants from the Fed in the immediate-term (i.e. a bailout of global stock and commodity markets), we are likely to see continued USD strength vs. peer currencies over the intermediate-term TREND. This would have potentially dour implications on the near-term returns of various asset classes (trailing 2MO correlations to the DXY): 

  • S&P 500: -0.92
  • EuroStoxx 600: -0.94
  • MSCI World Index: -0.94
  • CRB Index: -0.93
  • US Junk Bond Yields: +0.83 

As always, the Correlation Risk will eventually burn off, allowing for alpha generation to resurface in dynamic asset allocation strategies. Until that happens, however, expect the USD to continue to be the dominant driver of Global Macro beta (i.e. the directionality of various asset classes).  

 

Darius Dale

Senior Analyst


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