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Takeaway: 23x p/e is a tough risk/reward for a company that can barely grow EPS when the brand is hotter than ever.

We’re no more or less excited about owning Nike into the 4Q print to be reported after the close on Thursday. A few thoughts…

  1. Revenue Looks Good: We could see a slight beat on the top line. The company guided towards a high single digit rate. The brand still has solid momentum in the US and Western Europe. In ‘Nike Speak’ high-single digit sales guidance equals 11-12%. The Street is at 9.6%.
  2. Gross Margin Expectations Appropriately High: The Street is already looking for a 44.7% Gross Margin, which is 75bps ahead of last year and represents a meaningful sequential pick-up in the 2-year trend. We’re seeing a shift toward higher GM jurisdictions (which could also help tax rate), so this is a reasonable expectation. But we’d be surprised by much more – especially given that inventories ended the last quarter +15%.
  3. Need SG&A to Shine – and It Won’t: So with a likely slight sales beat, and in-line GM, that leaves it all up to SG&A to save the day.  The problem is that in all our years covering Nike, we have never seen the company spend money at the clip (even relative to size) that we’re seeing today. Nike is one of the best steward’s of capital in this industry, so it’s earned the benefit of the doubt as it relates to its capital allocation process which will ultimately result in increased cash flow at some point down the road. But with the company spending an estimated $100mm-$150mm on World Cup, we can’t exactly bank on this being the quarter for an SG&A beat. Let’s consider that number for a minute. This coming quarter, UnderArmour will spend about $55mm in marketing on EVERYTHING. Nike will spend 3x that on one sporting event.
  4. The World Cup Factor: A few people have told us “there’s no way Nike misses during World Cup”. That’s probably true. There’s no way it will allow itself to be in the financial press as disappointing while the biggest sporting match in the world is being played out . But mind you that Nike has not beaten by more than a penny in each of the past three World Cups.
  5. Nike’s biorhythm; The problem is that the Cup is always played in conjunction with Nike reporting its fourth fiscal quarter. Aside from Nike spending huge sums of capital on this event, you need to take into account Nike’s own internal financial biorhythm.  The same factors that lead to conservative goal setting between regional GMs and the C-Suite (and subsequent EPS smoking in quarters 1 through 3 also lead to muted upside in Q4). Why? If you are a business unit head at Nike, you have to fight for a given SG&A budget in a given year. If you don’t spend every last penny, then the chance of getting a similar (or larger) budget next year is slim to none. We’ve all heard the stories about what most people would consider excessive spending at Nike (ie. hiring rock bands to play at happy hour for your department). Most of those stories are true, and almost all happen in the fourth quarter.  The point is, if there is a quarter where you’re looking for NKE to beat on the SG&A line, 4Q probably won’t be the one – especially one where World Cup is being played in the back yard of Nike’s highest-profile National Team – Brazil.
  6. Guidance Not Headed Higher: The company already issued preliminary guidance for the May ’15 year “at or above our high-single-digit target range.“  It won’t come out and take guidance higher when the year is only four weeks old. They won’t take guidance down, either. But there’s an 80% chance it sticks with its previous comment, 15% chance it backs away, and 5% it guides higher.  

We’re not averse to owning Nike for someone who has an extremely long duration. But there’s no way we can justify putting money to work here for a company that is barely growing earnings when the brand is hotter than ever.  With the stock at 23x next year’s earnings, we simply think that there’s much better risk/reward elsewhere.  

NKE – Consider the World Cup Biorhythm  - nke financials