NKE: Flat Earnings, Four Years

Numbers are finally in post Q, but the Street is too high. NKE is in year 2 of a 4-year period of flat EPS. It could look cheap for a while. I’m so confident that we see a deal. A meaty one.

I’ve been sitting here patiently waiting for new (lower) consensus numbers post the biggest sequential slowdown in orders (on a 2-year trendline basis) in nearly 10-years. The verdict is in, and unfortunately, consensus numbers are too high. Fourth quarter looks OK, but Nike will have a down year in FY10. I can model a positive ’11, but that barely gets back above last year’s high water mark.

To say that I believe in what this company is doing strategically to manage earnings and take share is an understatement. So few companies are managing so proactively. But these positive actions come at a cost, and that cost is that for the next 18 months, Nike will not be considered a growth company. That puts valuation back in the ‘tweener’ category. Not cheap enough for a value investor, not growth enough for a less valuation-sensitive growth PM, and certainly not appealing to a momentum investor given my view that it will be missing numbers more often than not – until they are reset 10% lower.

There’s a critical theme here. Nike is a company that grows in ‘bursts’ and after each one it resets for a couple years until it races forward again. Keep in mind that each time it ‘reset’ the world thought that the growth story was dead, and it was proved wrong. Check out the stock chart below. I identified 4 ‘bursts’ over 20 years. 1) ramp in US footwear. 2) US apparel. 3) Int’l growth. 4) Subsidiaries (Converse, Golf, etc…). Each of these bursts required a completely different organization. The next opportunity is globally integrated categories, regions, and products. This is massively complex – moreso than anything Nike has ever done. The good news is that it has been investing in it for 2 years. It has flexibility to shift around assets, and pare back excess to maintain margin and protect growth. But it won’t be pretty.

My prediction… My estimate of flat earnings will be proved wrong because Nike’s gonna buy something. Potentially something sizeable. The cash burning a hole in its pocket is generating $0.04 per share less in income now than a year-ago, and this company does NOT like to be perceived as anything but a growth company. Even though the recent Umbro deal – where Nike wrote off over 60% of the value just 1.5 years after buying it – might go down as its most value-destroying deal since Cole Haan, I don’t think that this will spook this management team from deploying capital to deals. If anything, I think it will reiterate what has always been the case with the Nikester – it does not do well when it buys broken or bruised assets. It needs strong brands, over which it can leverage its infrastructure to make stronger (like it did with Converse. My top picks? Lululemon (after it implements its ERP platform – Nike won’t get in front of that, Remember i2?) and Timberland. I also think Zappos would be a slam-dunk from an infrastructure standpoint, but I’m not holding my breath on that one.

So what’s my bottom line? The stock looks cheap. But it is only 2-quarters into a ‘resetting’ phase which could conceivably last 2 years. This name might be cheap for a while.

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