THE HEDGEYE EDGE
Nike is the largest and most profitable brand in this GDP+ global growth industry. The self-imposed barriers to entry make it exceptionally difficult for anyone, anywhere to compete with Nike. The cost structure is simply too high. It controls about 50% of the US athletic footwear market, and about 15% of apparel. Its’ share outside the US is about 25% footwear, and 6% apparel.
Nike’s ownership of the supply chain offers exceptional flexibility during virtually every global economic climate, which not only self-perpetuates its growing market share, but also lowers the volatility of its earnings base. For examples, the US retailers that sell Nike can allocate up to 65% of inventory purchases to Nike. Most factory partners in Asia allocate near 100% of floor space to Nike. Who do you think holds the cards at each end? Nike is almost NEVER ‘surprised’ by a business-damaging closed-door decision by a retailer or sourcing partner. This allows it to always be on offense in driving its business, and in maintaining a margin premium versus competitors.
One of the biggest parts of the investment case for Nike is, unfortunately, something that requires a very big leap of faith on the part of the investor. That is, crediting Nike for driving innovation beyond the intermediate modeling time frame with product innovation that even the savviest consumers (and Wall Street analysts) cannot conceive of yet.
For example, people were asked three years ago if Nike had the capacity to change up the footwear manufacturing model such that the product is manufactured on a loom (i.e. a machine) as opposed to an assembly line of workers, most would say ‘No’. Yet today, Nike’s business is being driven by innovative products like FlyKnit, which is, in fact, manufactured on a machine similar to a cotton loom, and other products like Nike+ Fuel that digitizes a consumers’ movements and creates an on-line community of brand-loyal consumers. These are just a couple of examples of things that other brands literally cannot do without destroying their margin structure, or completely recapitalizing their balance sheets.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
NKE set beatable EPS expectations on its recent earnings call, which sets up a nice timeline of events. 1) A positive earnings report in September, 2) a long-awaited analyst meeting at HQ in Oct, and 3) benefit from price increases to take us through the end of the calendar year. Visibility is less certain as 2014 starts out, but then we start the ramp up to World Cup in Brazil. While soccer is a notch above Bass Fishing in the eyes of the US sportsman, the reality is that it is the biggest sport in the world by a country mile, and the World Cup is second only to the Summer Olympics (also in Brazil, but in 2016) in popularity. Simply put, the intermediate-term outlook for Nike is a good one.
LONG-TERM (TAIL) (the next 3 years or less)
Nike’s TAIL story is slightly boring, but that’s not a bad thing. In fact, we’d argue that boring and consistent is a multiple-enhancer. The reality is that the company has a defined plan to drive high-single digit sales growth on a global basis, and then trade off Gross Margin and SG&A in a given year to leverage its top line to low-mid teens operating profit growth. Then tack on the fact that Nike has a free cash margin in excess of 9%, the company has enough free cash to repurchase enough stock to drive another 5% EPS growth each year. Add it all up and we feel comfortable banking on at least 15% EPS growth each year. That’s not half bad for a large cap growth company that dominates a global duopoly.