Thursday's Print = Buy the News: Nike remains one of our favorite longs, as we think that estimates are low by 5% next year ($3.25)and 10% the year after ($3.75). But we don't think the 4Q print on Thursday is a 'buy ahead of the numbers' kind of event. In fact, we'd classify it more as 'buy the news' -- whether positive or negative. We think the company will beat, but in less sexy parts of the P&L like SG&A, while at the same time it should keep the lid on guidance for next FY. Recall that it was just 13 weeks ago that NKE guided for FY14 to be 'at or above' its high-single-digit top line long-term growth forecast, and 'at the high-end' of its low-mid teens long-term EPS growth target. Since then business conditions have remained relatively stable, but they clearly have not improved. As such one thing Nike absolutely won't do is let estimates go any higher for next year -- even if strong fundamentals suggest otherwise. They'll say what they have to in order to keep the Street grounded. Without any guidance upside, and with a lower-quality beat, we simply don't think this qualifies as a 'trade into the quarter'. That's especially the case with short interest sitting near historic lows. If the stock trades off on the news, then we get much more interested near-term.
Now we'll talk out of the other side of our mouth. It's probably a lousy short as well. Simply put, it’s an extremely high-quality leader in a Global duopoly with dominant market share, rising returns, 8% of its market cap in cash and a consensus that is underestimating the earnings power of the company 2-3 years out by 10-15%. Oh…and by the way, they're not going to let the stock tank only days after the announced voluntary retirement of one of the most popular executives in the company's history (Denson won't be a fall guy). Could it sell-off around a noisy quarter? Sure, especially at 18-19x next year's earnings. But it'd be an event that we'd look at to go the other way.
Here are some factors to consider headed into the print…
- If there is any considerable variability in NKE's numbers, we think it will be on the SG&A line -- as Nike laps a 24% boost in Demand Creation spending in 4Q of last year during the build-up for the Summer Olympics, the launch of the NFL business, and the kick off of the Nike+ Fuelband campaign. We'll take EBIT upside any way we can get it, but historically investors don't pay as much for SG&A-driven upside as they do revenue/gross profit upside.
- We think that Nike sandbagged with its expectation for a 50bp improvement in 4Q gross margins. The reality is that with 8.5% average growth in the top line over the past two quarters combined with 4% growth in inventories, the balance sheet is as clean as its been in over two years.
- Japan might only account for 5% of Nike's business, but you can bet that management will call it out much like Ralph Lauren did as it relates to volatility in business conditions and FX conversion headed into its upcoming Fiscal Year. It'll help Nike keep expectations grounded.
- Nike will start to anniversary the addition of the NFL license to its North American business. Our estimate is that this is on its way to being a $500mm business. That's about a third of the $1.5bn in growth that Nike North America should add this year. Keep this in mind as it relates to growth in North America, which will taper as this new business scales.
- In this quarter last year we saw a 1,800bn sequential roll in China futures. As it anniversaries those losses, we'll see Nike gain some of that back even without making heroic assumptions about any kind of rebound in China. This will be an important factor for top line growth in the upcoming year.
- Similarly, it was in 4Q of last year where we saw Emerging Markets futures (fall back and) touch 10% -- a level that suggests that the Emerging Markets are not Emerging. We've been highlighting this issue, and have seen orders tick up. Comparisons will be easier for the next three quarters (leading up to World Cup in Brazil next year).
Ultimately, we have evidence that the US is still healthy. If you want to be bearish on the US, it will need to be 3-4 quarters out which is when visibility gets cloudy. But then we've got greater contribution from China and Emerging Markets, and more importantly, we get into World Cup Territory in the summer of 2014 in Brazil. Our point is that it will be pretty tough to be a big bear on Nike's top line over the next 12 months.