Takeaway: Futures in-line, but with a meaningful beat. CFO likely to throw out a cautionary FX flag. It’s warranted. But numbers still look good.
While we might not like Nike as much as some of our key long ideas, we’re comfortable owning it into the print on Thursday. The general consensus out there is that we should see an in-line (ish) quarter, with continued strength in futures – and management throwing out an element of caution with guidance given that the Dollar has strengthened 6% against the Euro in the 13 weeks since NKE last gave guidance – and during that time NKE has actually gone up by 5%. We think all of that is true – sort of. Yes, futures are likely trending in the 10% range, and management will almost definitely use the FX environment as a way to keep estimates grounded for the remainder of the year. But the one thing the street is missing is the leverage on the P&L this quarter. The Street is looking for Nike to deleverage 9.3% sales growth into a measly 2% growth in EPS. We think that’s way too conservative.
We think that sales will be up by 12% in the quarter – despite a poor showing by Nike teams in the World Cup, the company definitely turned this into a very commercial revenue event – in traditional Nike style. Importantly, despite what should be a $390mm boost in SG&A (175bp deleverage), Nike should leverage its growth into 12-13 EPS growth. We’re at $0.97 versus the Street at $0.88. As a point of reference NKE’s $390mm SG&A boost for the quarter is 55% greater than UnderArmour’s entire annual marketing budget.
While we think the quarter will be big, we’re not going to gloss over the near-certain tempered FX-related guidance for the rest of the year. The chart below speaks volumes. No matter how you cut it, a strengthening dollar is bad for Nike’s P&L. If it leads to increased US consumption that could help the business in the home market, but let’s face it…Nike does not need any hand holding in the US to drive its business. Maybe it boosts US tourism abroad a bit, but we’re hard pressed to think that many people travel to distant lands to buy a pair of Nike kicks. Net/net, FX trends are bad. The company has a sophisticated hedging process, that protects it from about 75% of the FX move on its cost of goods (when it receives an order, it uses local currency to buy dollars forward and match its product costs – which are all sourced in dollars). But we’re more concerned about the translation effect of foreign-denominated profits. Nike does a pretty good job of offsetting the Gross Margin hit and unfavorable translation with hedging – which it does purely on a transactional basis as opposed speculative hedging – and as such, EPS growth is unlikely to slow materially due to FX. But in the 15+ years we’ve covered Nike, we have yet to find a time when investors paid as much in the earnings multiple for better ‘other income’ from favorable hedges as opposed to better organic gross margins.
If the stock were trading at 18x earnings, we could care less. But at a 24x p/e, it’s definitely something to consider. The other thing that could save Nike in an unfavorable FX environment is SG&A, which should slow dramatically over the course of the year. We’ve got 19% growth in Q1 going down to -1% by Q4 – and it could end up being much less than that. Again, we don’t think that people will pay as much for SG&A leverage as they will for GM improvement, but this is the beauty of the Nike model – they’ll almost always find a way to hit annual growth targets.
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Takeaway: August New Home Sales get a shot of adrenaline from the West, adding to the seeming conflict in various housing-related data series.
Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.
*Note - to maintain cross-metric comparability, the purchase applications index shown in the table below represents the monthly average as opposed to the most recent weekly data point.
Today's Focus: August New Home Sales & MBA Mortgage Applications
August New Home Sales
Taking a quick survey of the current landscape and the prevailing ping-pong match in housing data: New Home Sales hit a 6 year high in August alongside a big miss out of KBH and soft guidance out of TOL. Meanwhile, in perfect in-congruency, builder confidence hit a new high in September as both New Home Starts & EHS declined sequentially, Mortgage Purchase demand continues to plumb multi-decade lows, and the rate of change across the primary HPI measures (Case-shiller, Corelogic, FHFA) have begun to diverge for the first time in quite a while.
The ITB took its cues from KBH earlier this morning, but has been rallying since the release of this NHS report. Bigger picture, at -6.5% for the year, housing remains one of the worst performing asset classes YTD in an otherwise largely-teflon tape.
MBA Mortgage Applications
The Mortgage Bankers Association today released its weekly mortgage applications survey data for the week ended September 19th.
About New Home Sales:
Each month the Census Department releases the New Home Sales report, which measures the number of newly constructed homes that have been sold in the month. The difference between the New Home Sales report and the Starts and Permits report is that New Home Sales only includes single family spec homes built and sold by builders, and does not include condos, apartments, or owner-built units. This is why New Home Sales typically run at roughly half the rate of Starts.
About MBA Mortgage Applications:
The Mortgage Bankers’ Association’s mortgage applications index covers more than 75% of mortgage applications originated through retail and consumer direct channels. It does not include loans delivered through wholesale broker and correspondent channels. The MBA mortgage purchase applications index is considered a leading indicator of single-family home sales and construction. Moreover, it is the only housing index that is released on a weekly basis.
The MBA Purchase Apps index is released every Wednesday morning at 7 am EST.
Joshua Steiner, CFA
Christian B. Drake
Takeaway: It's 'Groundhog Day' at the Fed according to Hedgeye CEO Keith McCullough.
Hedgeye CEO Keith McCullough spent the full hour with Fox Business host Maria Bartiromo on “Opening Bell” this morning. In this clip, McCullough explains his non-consensus call on why the Yellen Fed is set to get easier, why the Russell 2000 is in an epic bubble and how to position yourself right now.
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